CORPORATIONS for LLMs
                          (Prof. Pinto – Fall 2004)

1. Agency   7

  (a) Definition 7
  (b) Form  7
  (c) Types of Agent   7
    (i) The servant-agent    8
    (ii) The non-servant agent    8
    (iii) A subagent   8
  (d) Authority of the Agent:     8
    (i) Express Actual Authority  8
    (ii) Implied Actual Authority 8
    (iii) Apparent Authority 8
    (iv) Emergency Authority 8
    (v) Caveat    8
  (e) Termination:     8
  (f) Ratification     8
  (g) Agent’s Liability      9
  (h) Agency Costs:    9
  (i) Cases:     9
      (i) Hoddeson     9

2. Corporate v. Partnership form  9

  (a) Corporation      9
  (b) Partnership      9
  (c) Key Considerations     9
    (i) Limited Liability    9
    (ii) Free Transferability of Interests    10
    (iii) Continuity of Existence 10
    (iv) Centralized Management   10
    (v) Access to Capital    10
    (vi) Taxation 10
  (d) Limited Partnership    10

3. Where and How to Incorporate   10

  (a) Incorporator     10
  (b) Articles of Incorporation:  11
  (c) Bylaws     11
  (d) Corporate Existence    11
  (e) Choice of Law    11
  (f) Delaware   11

4. Types Of Securities And Capital Structure 11

  (a) Capital Structure      11
  (b) Concerns   11
    (i) Risk      11
    (ii) Control  11
    (iii) Return  11
  (c) Securities 11
  (d) Debt  11
    (i) Bonds     11
    (ii) Debentures    12
  (e) Common Shares    12
  (f) Preferred Shares 12
  (g) Leveraging 12
    (i) Problem   12
    (ii) Benefit  13

5. Accounting    13

  (a) Balance Sheet    13
    (i) Assets    13
    (ii) Liabilities   13
    (iii) Equity  13
  (b) Income Statement 13

6. Valuation     14

  (a) Liquidation Value      14
  (b) Book Value 14
    (i) Cost Based Accounting     14
    (ii) Depreciation  14
    (iii) Intangible Assets  14
  (c) Earnings Approach      14
    (i) Capitalization of Earnings      14
    (ii) Cash Flow     14
  (d) Cases 14
      (i) Taines  14

7. Capital Markets And ECMH  15

  (a) Stock Markets    15
    (i) Benefits  15
    (ii) Shareholder Protection   15
  (b) Efficient Capital Market Theory (ECMT)  15
    (i) “Weak version”:      15
    (ii) “Semi–strong version”:   15
    (iii) “Strong version”:  15
  (c) Separation of Ownership from Control    15

8. Securities Regulation     15

  (a) Purposes   15
  (b) Securities Act of 1933 16
  (c) Securities Exchange Act of 1934   16
  (d) Rule 10b–5 16

9. State Law Requirements On Issuance Of Shares And Dividends 16

  (a) Issuance of Shares     16
    (i) Preemptive Rights    16
    (ii) Par Value     16
  (b) Dividends  16
  (c) Cases 17
      (i) Dodge v. Ford      17

10. Corporation In Society And Ultra Vires   17

  (a) Ultra Vires      17
  (b) Social Responsibility  17
  (c) Cases 17
      (i) Shlensky v. Wrigley      17

11. Promoters    18

  (a) Definition 18
  (b) Liability  18

12. Defective Incorporation  18

  (a) Definition 18
  (b) De Facto Corporation   18
    (i) Elements  18
    (ii) Caveat   18
  (c) Corporation by Estoppel     18
    (i) Caveat    18

13. Piercing The Corporate Veil   19

  (a) Definition 19
  (b) Grounds for Piercing   19
    (i) Intermixture of Affairs   19
    (ii) Lack of Corporate Formalities  19
    (iii) Inadequate Capitalization     19
    (iv) Evasion of a Contract    19
    (v) Instrumentality Theories  20
  (c) Equitable Subordination     20
  (d) Cases 20
      (i) Walkovsky v. Carlton     20
      (ii) Kinney 20

14. Theories Of The Firm     20

  (a) Regulatory Approach    20
  (b) Management Approach    20
  (c) Law and Economics Approach  20

15. Shareholders And Monitoring   20

  (a) The Legal Model  21
  (b) Shareholders     21
    (i) Election of Directors     21
    (ii) Relationship  21
    (iii) Right to Vote:     21
    (iv) Proxy Voting  21
    (v) Proxy Fight    21
    (vi) Shareholder Democracy    22
    (vi) Vote Buying   22
    (vii) Right of Expression     22
    (viii) Right of Information   22
  (c) Cases 22
      (i) Auer v. Dressel    22
      (ii) Schnell     22
      (iii) Blausius v. Atlas Corp 22
      (iv) General Datacomm  23
      (v) Pillsbury v. Honeywell   23

16. Board Of Directors 23

  (a) Basic Principles 23
  (b) Board Structure  23
  (c) Independent Directors  23
  (d) Meetings   23

17. Officers     23

  (a) Basic Principles 23
  (b) Authority  23

18. Federal Proxy Rules      24

  (a) Basic Principles 24
  (b) Proxy Solicitation     24
  (c) Proxy Contest    24
    (i) Caveat    24
  (d) Antifraud Rule   24
    (i) SEC Rule 14a–9 24
    (ii) State Law     24
    (iii) Standing to Sue    25
    (iv) Materiality   25
    (v) State of Mind (Fraud) Required  25
    (vi) Causation     25
    (vii) Remedies     25
  (e) Cases 25
      (i) J.I. Case Co. v. Borak   25
      (ii) Mills v. Electric Auto–Life Co.    25

19. Shareholder Proposals    25

  (a) SEC Rule 14a–8 Proposal:    25
    (i) Types of Proposals   25
    (ii) Eligibility and Procedure      25
    (iv) Proxy Proposal Process   26
    (v) Ordinary Business Operations Exclusion     26
    (vi) Other Exclusions    26
  (b) Cases 27
      (i) Medical Committee for Human Rights v. SEC      27

20. Fiduciary Duties – Overview   27

  (a) General    27
  (b) Duty of Care     27
  (c) Duty of Loyalty  27
  (d) Other Standards of Judicial Review:     28
    (i) Modified Business Judgment Rule 28
    (ii) Waste Standard      28
  (e) Level of Judicial Scrutiny  28
  (f) Duty of Disclosure     28

21. Duty Of Care 28

  (a) Standard of Care 28
  (b) Duty to Monitor  29
  (c) Business Judgment Rule 29
  (d) Causation  29
  (e) Duty to Act Lawfully:  29
  (f) Caveat     29
  (g) Responsibility for     29
  (h) Statutes   30
    (i) ALI § 4.01     30
    (ii) Delaware § 102(b)(7)     30
  (i) Cases 30
      (i) Francis v. United Jersey Bank 30
      (ii) Smith v. Van Gorkom     30

22. Duty Of Loyalty    30

  (a) General    30
  (b) Interested Director Transactions  30
    (i) Analysis  30
    (ii) New York Statute    30
  (c) Cases 31
      (i) Lewis v. S.L. & E., Inc. 31

23. Executive Compensation   31

  (a) General    31
    (i) Stock Options  31
  (b) Judicial Review  32

24. Corporate Opportunity    32

  (a) General    32
  (b) Legal Tests:     32
    (i) Interest Test  32
    (ii) Line of Business Test    32
    (iii) Fairness Test      33
    (iv) The ALI Test  33
  (c) Cases 33
      (i) Northeast Harbor Golf Club, Inc. v. Harris     33

25. Controlling Shareholders And Sale Of Control   33

  (a) Controlling Shareholders    33
  (b) Fiduciary Duty   34
    (i) Caveat    34
  (c) Sale of Control  34
    (i) General View   34
    (ii) Looting  34
    (iii) Securities Law     34
  (d) Cases 34
      (i) Perlman v. Feldmann      34

26. Derivative Suits   34

  (a) General    34
  (b) Direct Action    34
  (c) Derivative Action      34
    (i) Requirements to Plaintiffs      35
    (ii) Caveat 1 35
    (iii) Caveat 2     35
    (iv) Caveat 3 35
  (d) Demand Rule      35
    (i) Demand Refused 35
    (ii) Demand Accepted     35
    (iii) Demand Excused     36
  (e) Special Litigation Committees     36
  (f) Cases 36
      (i) Marx v. Akers      36

27. Mergers And Acquisitions 37

  (a) General    37
  (b) Direct Merger    37
  (c) Consolidation    37
  (d) Triangular Merger      37
  (e) Reverse Triangular Merger   37
  (f) Sales of Assets  37
  (g) Tender Offer     37
  (h) Appraisal Remedy 37
    (i) Delaware Block Approach   37
    (ii) New Methodology     38
  (i) Defacto Merger   38
  (j) Cases 38
      (i) Piemonte v. New Boston Garden Corp. 38

28. Freezeouts Under State Law    38

  (a) Freezeouts 38
    (i) Two–tier Offer 38
    (ii) Front–loaded Two–tier Offer    38
  (b) State Law  38
  (c) Shareholder Ratification:   39
  (d) Cases 39
      (i) Weinberger v. U.O.P. Inc.     39
      (ii) In Re Wheelabrator Technologies Litigation    39

29. Hostile Takeovers  39

  (a) General    40
    (i) proxy fight    40
    (ii) tender offer  40
  (b) Bidder Tactics   40
  (d) Target Tactics   40
    (i) Shareholder Vote Required 40
    (ii) Shareholder Vote Not Required: 41
  (e) State Law  41
    (i) The Unocal Test      41
    (ii) The Revlon Test     42
  (f) Summary    42
  (g) Cases 42
      (i) Moran v. Household International, Inc.   42
      (ii) Revlon, Inc. v. MacAndrews   42
      (iii) Paramount Communications, Inc. v. Time, Inc. 43
      (iv) Paramount Communications, Inc. v. QVC Networks, Inc.     43

30. Rule 10B–5   43

  (a) Scope 43
    (i) Disclosure     43
    (ii) Insider Trading     43
  (b) Private Rights of Action    43
  (c) Standing to Sue  43
  (d) Materiality      43
  (e) State of Mind    43
  (f) Reliance (Transaction Causation)  44
  (g) Reliance (Fraud on the Market Theory)   44
  (h) Loss Causation   44
  (i) The “In Connection With” Requirement    45
  (j) Privity    45
  (k) Secondary Liability for Disclosure Violations      45
  (l) Freezeouts 45
  (m) Cases 45
      (i) Basic, Inc v. Levinson   45
      (ii) Santa Fe v. Green 45
      (iii) Diamond v. Oreamuno    46

31. Insider Trading    46

  (a) Nature of the Insider Trading Prohibition    46
  (b) Who is an Insider?     46
    (i) SEC Rule 14e–3 46
  (c) Tipper–Tippee Liability     46
    (i) Benefit Test   47
  (d) The Misappropriation Theory 47
  (e) Remedies and Enforcement    47
  (f) Insider Trading Prohibition under State Law  47
  (g) Cases 47
      (i) Chiarella v. United States    47
      (ii) Dirks v. SEC      48
      (iii) United States v. O’Hagan    48

32. Closely–Held Corporations     49

  (a) General    49
    (i) Ex Ante protection   49
    (ii) Ex Post protection: 49
  (b) Devices to Maintain Control 49
    (i) Shareholder Voting Agreement    49
    (ii) Irrevocable Proxies 49
    (iii) Voting Trusts      50
    (iv) Class Voting  50
    (v) Cumulative Voting    50
    (vi) Supermajority Voting requirements    50
  (c) Protecting Shareholder Expectations Ex Ante  50
  (c) Restrictions on Share Transferability   50
    (i) Umbrella Test  51
  (e) Protecting Shareholder Expectations Ex Post  51
    (i) Summary of Choices   51
  (e) New York Statutory Provisions     51
  (f) Cases 51
      (i) McQuade v. Stoneham      51
      (ii) Clark v. Dodge    51
      (iii) Wilkens v. Springside Nursing Home     52
      (iv) Kemp v. Beatley   52

1. Agency

(A) DEFINITION: A FIDUCIARY RELATION WHICH RESULTS  FROM  THE  MANIFESTATION
OF CONSENT BY ONE PERSON TO ANOTHER THAT THE OTHER SHALL ACT ON  HIS  BEHALF
AND SUBJECT TO HIS CONTROL AND CONSENT BY THE OTHER SO TO  AT.  (RESTATEMENT
– AMERICAN LAW INSTITUTE).

Agency relationship can be defined as a contract under  which  one  or  more
persons (the principal) engage another person (the agent)  to  perform  some
service on their behalf  which  involves  delegating  some  decision  making
authority to the agent.

The relation is objective  –  i.e.  the  name  the  parties  attach  to  the
relationship is irrelevant.

(b) Form: usually contractual, usually written. There is an agency  relation
even if a written contract or the word agency are not used.

      (i) Power of attorney.

      (ii) Appointment to a position (e.g. general manager of a business).

(c) Types of Agent: there are different types of agents:

      (i) The servant-agent (or employee): the name refers to the fact  that
      he is subject to control of the principal both as to  what  is  to  be
      done and as to his physical activities.

      (ii) The non-servant agent is subject to the principal’s control as to
      what is to be done, but not as to HOW  it  is  to  be  done  (physical
      activities).

      (iii) A subagent is an agent of the non-servant agent, and  thus  acts
      on the principal’s behalf (eg: the associate at a law firm  contracted
      by a corporation). The subagent owes  fiduciary  duties  both  to  the
      agent and to the principal.

(d) Authority of the Agent: if agent acts with actual  authority,  principal
is bound. However, if agent does not have authority, the  principal  is  not
bound. Not all actions by the agent will bind the principal.

      (i) Express Actual Authority: explicit manifestation.

      (ii) Implied Actual Authority:  authority  reasonably  or  customarily
      implied from  a  more  general  grant  of  express  actual  authority.
      Implication can result from the manager’s title  or  behavior  of  the
      principal.

      (iii) Apparent Authority: conduct by the principal causes third  party
      reasonably to believe agent has actual  authority;  principal  may  be
      bound. Apparent authority can be created when the agent is  out  doing
      things that third parties could reasonably expect the agent to do  (in
      this case the principal is liable to the third parties but  the  agent
      is liable to the principal).

      (iv) Emergency Authority:  activity  not  within  the  limits  of  the
      agency, but due to  emergency  reasons  is  extended  to  protect  the
      principal.

      (v) Caveat:

           (1) In most cases of apparent authority,  an  implied  authority
           coexists. In naming a manager,  the  principal  creates  implied
           authority  to  the  manager  and  apparent  authority  to  third
           parties.

           (2) Either actual or apparent authority binds the principal.

           (3) Principal may  ratify  the  authority  either  expressly  or
           implicitly.

           (4)  Usually,  the  agency  relationship  will  entail   implied
           authority. This  means  that  the  principal  may  be  bound  to
           unforeseen things, in order to protect third parties.

(e) Termination:

      (i) at will, by either party;

      (ii) death or incapacity, even if neither the agent  nor  third  party
has knowledge.

(f) Ratification: principal may ratify an  act  executed  by  agent  without
actual or apparent authority.

      (i) need not be communicated to agent or third party to be  effective;
      principal’s conduct is key;

      (ii) may be accomplished by  express  statement,  may  result  from  a
      principal’s acquiescing in the transaction or taking action consistent
      only  with  ratification  (e.g.  suing  to  enforce  the  unauthorized
      contract);

      (iii) principal must have knowledge of the essential facts  concerning
      the transaction;

      (iv) usually require the same formality as creation of  the  authority
      in the first instance.

(g) Agent’s Liability: agent may  be  liable  to  third  party  when  acting
without actual or apparent authority and principal does not ratify the act.

(h) Agency Costs: costs incurred by principal to control the agent.

      (i) monitoring costs;

      (ii) bonding costs (payment to agent to expend resources to  guarantee
      against actions that would harm principal and to assure loyalty); and

      (iii) residual loss (costs associated to divergences between principal
      and agent – ordinary costs, like telephone bills).

(i) Cases:

      (i) Hoddeson (materials): apparent authority binds the principal  only
      if the appearance of authority was created by  the  manifestations  of
      the principal and not alone by proof of those of the supposed agent.

2. Corporate v. Partnership form

(A) CORPORATION: LIST OF  REQUIREMENTS,  INCLUDING  FILING  OF  ARTICLES  OF
INCORPORATION WITH THE STATE.

(b) Partnership: association of 2 or more persons to carry on  as  co–owners
a business for profit. Two people can be partners and not now it – it  is  a
matter of law and not of the name the parties attach to the relationship.

      (i) no formal or written agreement  required;  results  from  contract
      expressed or implied.

      (ii) profit sharing and control: main elements.

      (iii) in the lack of contract, Uniform Partnership Act (UPA or Revised
      UPA) governs.

(c) Key Considerations (basic legal differences between a corporation and  a
partnership):

      (i) Limited Liability:

           (1) Partnership: generally legally viewed as  the  aggregate  of
           its owners; each owner is personally liable for the debts of the
           partnership.

           (2)  Corporation:  separate  legal  entity;   shareholders   are
           shielded from personal liability (only lose their investments in
           the corporation).

      (ii) Free Transferability of Interests:

           (1)  Partnership:  not  freely  transferable;  addition  of  new
           partner requires unanimous consent.

           (2) Corporation: free transferability.

      (iii) Continuity of Existence:

           (1)  Partnership:  change  in   partnership   results   in   its
           dissolution; death or bankruptcy of partner causes  dissolution;
           may be terminate by desire of any partner

           (2) Corporation: not affected by death, bankruptcy or desire  of
           a shareholder to terminate; perpetual existence.

      (iv) Centralized Management:

           (1) Partnership: all partners  participate  in  the  management;
           each partner may bind the partnership as agent.

           (2) Corporation: board of directors,  elected  by  shareholders;
           centralization of management separate from owners.

      (v) Access to Capital:

           (1) Partnership: less  access  to  capital;  not  attractive  to
      investors.

           (2)  Corporation:  basic  characteristics   listed   above   are
           attractive to investors.

      (vi) Taxation:

           (1) Partnership: not subject to taxation.

           (2) Corporation: pay tax as a legal entity; pay  on  the  income
           received and again when income is distributed to shareholders as
           dividends.

                 (I) S Corporation: all income is taxed to the shareholders,
                 whether or not such income is actually distributed to them;
                 treated like a partnership for tax purposes.

(d)  Limited  Partnership:  provides  partnership–style  tax  treatment  and
limited liability for some of the owners; must have  at  least  one  partner
with unlimited liability; if partner gets involved in  the  control  of  the
partnership, partner may lose limited liability.

3. Where and How to Incorporate

(A)  INCORPORATOR:   RESPONSIBLE   FOR   FILING   THE   AOI   (ARTICLES   OF
INCORPORATION, ALSO CALLED CHARTER OR CERTIFICATE  OF  INCORPORATION);  MUST
ADOPT A SET OF BYLAWS, HOLD INITIAL SHAREHOLDERS’ AND  DIRECTORS’  MEETINGS,
ARRANGE FOR ELECTION OF DIRECTORS AND OFFICERS,  OPEN  BANK  ACCOUNT,  ISSUE
SHARES, OTHER INITIAL ACTS.

(b) Articles of Incorporation: basic information of  the  company  and  must
comply with statutory requirements.

(c) Bylaws: internal rules dealing with the governance of  the  corporation;
not publicly filed.

(d) Corporate Existence: begins upon acceptance of  the  AOI  by  the  state
official.

(e) Choice of Law: every state has  a  corporate  statute  and  common  law;
state law  governs  most  intra–corporate  relationships  (internal  affairs
doctrine).

(f) Delaware: dominates; arguably, state  laws  favor  corporate  management
over shareholders.

4. Types Of Securities And Capital Structure

(A) CAPITAL STRUCTURE: AMOUNT AND  TYPE  OF  DEBT  AND  EQUITY.  CAPITAL  IS
RAISED BY BORROWING (DEBT) AND INVESTMENT OF OWNERS (EQUITY).  DEBT  CREATES
A CREDITOR RELATIONSHIP, EQUITY CREATES AN OWNERSHIP RELATION.

      (i) creditors have priority over equity holders and interest  must  be
      paid before dividends are paid to shareholders.

      (ii) generally, interest paid to creditors is tax deductible.

      (iii) dividends are paid when there  are  profits  and  the  board  of
      director so determines.

(b) Concerns: there are three main concerns when investing in a corporation

      (i) Risk: the concern is getting back your investment.

      (ii) Control: who has actual control of the corporation

      (iii) Return: if the company is successful, who gets the benefits?

(c) Securities: common stock, preferred shares  and  debt,  with  attributes
relating to risk of loss, power to  control  the  business  and  ability  to
share in success of the enterprise.

      (i) Investors expect return and compensation for inflation,  for  risk
      (only US government guaranteed securities are risk–free), and for lost
      of opportunity (investment in one business means funds cannot be  used
      for other investments).

      (ii) Risk is the primary factor to be weighed against potential return
      in deciding between investments.

(d) Debt: bonds or debentures  (long  term  debt  instruments,  generally  5
years).

      (i) Bonds: usually secured by specific assets (mortgage on property).

           (1) Borrower shall pay a fixed amount  of  interest  at  regular
           intervals and pay face value (or par value) at maturity.

           (2) Total annual interest  payment:  nominal  interest  rate  or
           coupon rate (when expressed as a percentage of face value).

           (3) Bond holders have no say in the running of the company.

           (4) They do not benefit if the company grows.

      (ii) Debentures: unsecured debt (holders have  a  general  claim  with
      other creditors). It is less secure than bonds, but more  secure  than
      equity. No say in the running of the business.  In  some  cases  there
      might be a contractual provision limiting the activity of the  company
      in order to protect the loan.

      (iii) If the debt is sold  to  the  public,  the  contract  is  called
      indenture and a trustee may be selected to represent holders.

           (1) Indenture contains covenants (agreements and obligations  of
           the issuer). Obligations may include  maintenance  of  property,
           restrictions on dividends, on additional debts, negative  pledge
           clause (issuer may not issue new debt with a  security  interest
           in already–owned property), limitations on mergers  and  changes
           of control, same business, financial stability.

      (iv)  Creditors  do  not  receive  more  money  if  the  business   is
      successful, unless if  debt  is  made  convertible  to  common  shares
      (allows for a fixed return but with option on shares  if  their  value
      increases).

(e) Common Shares: common shareholders have a claim to  receive  the  income
and assets of  the  corporation  only  after  all  other  claims  have  been
satisfied (residual claim).

      (i) Common  shareholders  usually  have  significant  control  of  the
      corporation: voting rights (select the board).

      (ii) Lower priority, greater risks of loss but potential  for  greater
      return than other investments.

(f) Preferred Shares: equity authorized by statute (usually in the AoI).

      (i) In most cases,  preferred  are  paid  fixed  dividends  after  the
      creditors are paid their interest, but before common.

      (ii)  Preferred  are  paid  when  authorized  by  the  board  (usually
cumulative).

      (ii) In liquidations, preferred are paid after creditors,  but  before
common.

      (iii) Lower priority (but  greater  than  common),  higher  risk  than
      creditors in receiving a return and repayment; no  vote  (no  control)
      and no share in the increased return if the corporation is  successful
      (except if contractually provided for).

      (iv) Attract investors because tend to pay higher dividends.

(g) Leveraging: use of debt creates leverage  by  allowing  debtors  to  put
creditors’  funds  at  risk  (“other  people’s  money”),  requiring  smaller
investment of equity by owners.

      (i) Problem: failure to pay interest on debt  can  trigger  a  default
      (may lead to bankruptcy). There is also risk that  the  company  won’t
      make money.

      (ii) Benefit: payment of interest is tax deductible,  so  the  company
      ends up paying less taxes.

5. Accounting

(A) BALANCE SHEET: FINANCIAL PICTURE OF THE BUSINESS ON ONE PARTICULAR  DAY.
DIVIDED IN ASSETS AND LIABILITIES AND  EQUITY.  THERE  ARE  TWO  METHODS  OF
“COUNTING” IN THE BALANCE SHEET: FIFO (FIRST IN, FIRST OUT)  OR  LIFO  (LAST
IN, FIRST OUT) – THIS CAN HAVE AN EFFECT IF THERE IS  A  RAPID  TURNOVER  OF
GOODS OR INFLATION.

      (i) Assets (A = L + E): current assets, fixed assets and intangibles.

           (1)  Current  Assets:  include  cash,   marketable   securities,
           accounts receivable, inventories, prepaid expenses (assets  that
           may be turned into cash in the reasonably near future).

           (2) Fixed Assets: property, plant and equipment (listed at their
           original  cost  less   depreciation).   A   company   may   take
           depreciation in the balance sheet. It is cumulative. It  has  to
           be written  off  in  both  the  balance  sheet  and  the  income
           statement.

           (3) Intangibles:  assets  having  no  physical  existence  (e.g.
      patent, goodwill).

      (ii) Liabilities (L =  A  –  E):  current  liabilities  and  long–term
liabilities.

           (1) Current Liabilities: all debts due within  the  coming  year
           (accounts payable,  notes  payable,  accrued  expenses  payable,
           Federal income tax payable).

           (2) Long–term Liabilities: debts due after  one  year  from  the
           date  of  the  financial  report  (deferred  income  taxes   and
           debentures).

      (iii) Equity (E  =  A  –  L):  stated  capital,  capital  surplus  and
      accumulated retained earnings (total ownership interest; corporation’s
      net worth).

           (1) Stated Capital: usually par value of the stock multiplied by
           the number of issued and outstanding shares (includes  preferred
           stocks and common stocks).

           (2) Capital Surplus: amount paid in by shareholders  in  payment
           for their shares in excess of the par value.

           (3) Accumulated Retained Earnings: earnings not  distributed  as
      dividends.

      (iv) What it shows that is good for analysis: working capital, current
      ratio, liquidity ratio, inventory turnover, net book value, net  asset
      value, capitalization ratio, bond ratio, preferred stock ratio, common
      stock ratio.

(b) Income Statement: shows how the company  has  fared  over  a  period  of
time, how profitable the company is.

      (i) Basically, shows net sales, costs and net profit.

      (ii) What it shows that is good  for  analysis:  operating  margin  of
      profit, operating cost ratio, net profit ratio.

6. Valuation

(A)  LIQUIDATION  VALUE:  AMOUNT  FOR  WHICH  ASSETS  COULD  BE  SOLD  MINUS
LIABILITIES. DOES NOT REFLECT BUSINESS POTENTIAL.

(b) Book Value: based on balance sheet. Equity may be  referred  to  as  the
book value. Poor valuation, for the following reasons:

      (i) Cost Based Accounting: based on cost, not on market; conservative.

      (ii)  Depreciation:  fixed  assets  on  the  balance  sheet   may   be
      undervalued and depreciation may make it worst.

      (iii) Intangible Assets: usually not represented at  market  value  on
      the balance sheet.

(c)  Earnings  Approach:  takes  the  future  into  account  and   evaluates
inflation, opportunity cost and risk; present  value  of  a  future  return.
Interest  rate  reflects  the  best  guess  estimate  on   the   prospective
inflation, risk of the debtor paying and opportunity  cost.  Businesses  are
valued for their ability to make money.

      (i) Capitalization of Earnings: how much should I invest today (P)  to
      earn a certain amount per year forever (A) at a certain rate (R)?

              A

      P = ― , where:

             R

      P is present value;

      A is annual return; and

      R is the rate.

           (1) Calculation of the appropriate rate  depends  on  inflation,
           opportunity cost and risk. First you look at US treasury  bonds,
           since they are risk free. To  invest  in  something  other  than
           government bonds you require a higher R.  Getting an adequate  R
           is complicated. It is usually done by:

                 (I) looking at what comparable businesses sold for.

                 (II) looking at comparable businesses in the stock market.

       (ii) Cash Flow: the amount the owner would have for actual use.

(d) Cases:

      (i) Taines: the court took into  account  the  investment  value  when
      deciding the value of the  business.  The  judge  took  the  projected
      future cash flow, used a multiplier of 2 (50% rate) to get a value for
      the company.

7. Capital Markets And ECMT

(A) STOCK MARKETS: MARKETS FOR THE TRADING OF SHARES  (SECONDARY  MARKETS  –
COMPANIES DO  NOT  SELL  THEIR  SHARES,  STOCKHOLDERS  SELL  THEIR  SHARES);
PROVIDES LIQUIDITY AND DISCIPLINE.

      (i) Benefits: numerous investment  choices,  diversification;  capital
      for modernization or expansion; costs are  lower  than  private  sale;
      liquidity, which lessens the risk to investors.

      (ii) Shareholder Protection: disclosure, fair–trading,  fraud,  market
      manipulation, insider trading.

(b) Efficient Capital Market Theory (ECMT):  traders  in  the  stock  market
react quickly and  efficiently  to  information.  New  information  about  a
company is immediately reflected in the price of  the  shares.  Stocks  move
randomly, not irrationally. The fact that the market is  efficient  suggests
several things:

      (i) “Weak version”: past price information  does  not  enable  one  to
      predict the future price movements.

      (ii) “Semi–strong version”: market price quickly reflects all publicly
      available information.

      (iii) “Strong version”: even non–public information  is  reflected  in
      price. Thus this reflects the value of the company  (this  proposition
      is arguable).

      The  theory  does  not  take  into  account  that  people  often   act
      irrationally and thus te market may act irrationally.

(c) Separation of Ownership  from  Control:  beneficial  when  the  managers
operate the business in ways that benefit  the  shareholders;  managers  are
specialists. If not, owners may suffer losses or insufficient gains.

8. Securities Regulation

(A) PURPOSES:  PROVIDE  FULL  DISCLOSURE  WHEN  COMPANIES  SELL  SECURITIES;
PROVIDE INFORMATION (ENABLE  INVESTORS  TO  MAKE  WELL–INFORMED  INVESTMENTS
DECISIONS) AND PROHIBIT MISREPRESENTATION, DECEIT AND FRAUD.

      (i) Requires registration: full disclosure  (description  of  business
      and  assets;  provisions  of  the  security;   management;   financial
      statements).

      (ii) Companies seeking to have their securities  listed  and  publicly
      traded (in the national exchange market, and companies with assets > $
      10MM and at  least  500  shareholders,  traded  over–the–counter,  are
      subject to registration with the SEC (1934 Act).

      (iii) SEC role is to protect investors, not shareholders.

(b) Securities Act of  1933:  governs  initial  issuance  of  securities  by
corporations. The main basis  of  the  act  is  full  disclosure  about  the
company and its financial and  business  assets.  Both  the  Government  and
individuals can bring claims against liable parties.

(c) Securities  Exchange  Act  of  1934:  governs,  inter  alia,  subsequent
trading and other activities respecting securities.  It  deals  mostly  with
the stock market and related issues.  It  creates  the  obligation  of  full
disclosure,  and  thus  liabilities  for  failure  to   comply   with   this
obligation.

(d) Rule 10b–5: authorizes a defrauded buyer or seller  to  sue  in  federal
court if a material misstatement or non–disclosure  is  made  in  connection
with a purchase or sale of security.

9. State Law Requirements On Issuance Of Shares And Dividends

(A) ISSUANCE OF SHARES: NUMBER OF SHARES  AUTHORIZED  (AVAILABLE  FOR  SALE)
MUST BE STATED IN THE AOI (STATES WILL USUALLY  CHARGE  A  COMPANY  FOR  THE
AMOUNT OF SHARES AUTHORIZED TO ISSUE); CORPORATIONS USUALLY HAVE  AUTHORIZED
MORE SHARES THAN THEY PLAN  TO  SELL;  SHARES  ALREADY  AUTHORIZED  BUT  NOT
ISSUED CAN BE ISSUED AT THE DISCRETION OF THE BOARD.

      (i) Preemptive Rights: require that each shareholder  be  offered  the
      right to purchase  a  proportionate  number  of  shares  in  order  to
      maintain the percentage of ownership and voting control. They have  to
      be provided for in the AoI.

           (I) Publicly  traded  corporations  do  not  provide  preemptive
           rights, taking into  account  the  characteristics  of  publicly
           traded companies, it does not make much sense.

           (II) In a closely held corporation it is  thought  that  if  the
           shareholders want that right they should contract them.

           (III) The  argument  is  that  it  limits  the  ability  of  the
           corporation to use the shares for other things than ownership.

      (ii) Par Value: minimum price for which shares  may  be  sold;  today,
      either low par or no par shares are usually issued  and  there  is  no
      minimum capital requirement. There were  historical  reasons  for  par
      value, but they are no longer relevant.

(b) Dividends: payments to shareholders which represent a current return  on
investment. Paid at the discretion of the board.

      (i) As a basic principle, dividends are  not  permitted  when  payment
      adversely impacts investors or creditors, or when the  corporation  is
      equitably insolvent.

      (ii) In order to distribute dividends, statutes usually require Earned
      surplus (net profits retained), or earned surplus and capital  surplus
      (stock is issued at a par value lower  than  the  price  it  is  sold;
      company, therefore, has a stated capital (par value multiplied by  the
      number of stocks) and a capital surplus (resulted from the  difference
      between the par value and the price the stock was actually sold)).

      (iii) The Revision of the  Model  Business  Corporation  Act  of  1984
      (RMBCA) uses a balance sheet test to determine whether  dividends  can
      be distributed: after a distribution, assets must exceed  the  sum  of
      liabilities and the total amount owned to preferred shareholders on  a
      liquidation.

(c) Cases:

      (i) Dodge v. Ford: the court held that the powers of directors must be
      exercised in the benefit of the company and found that  directors  had
      no reasons not to pay dividends; although normally  protected  by  the
      business judgment rule, the court ordered the payment of dividends  to
      the shareholders.

      The argument for this move was that the decision not to pay  dividends
      was not a business decision.  Although  one  aim  was  to  expand  the
      company, the main aim of the move was to be able to lower the price of
      cars  and  benefit  the  consume.  Further,  it  was  a  closely  held
      corporation, in which case the court is more likely to get involved in
      the business decisions to protect minority shareholders.

      The importance of the case is that it clearly states that the main aim
      of a corporation is to make money and profit for its shareholders.

10. Corporation In Society And Ultra Vires

(A) ULTRA VIRES: IT IS THE IDEA THAT A CORPORATION HAS LIMITED POWERS AND
THAT ANYTHING BEYOND THOSE POWERS IS NOT WITHIN THE AREA THE CORPORATION
CAN ACT IN.

      (i) If the ultra vires defense holds up it has the drawback that third
      parties get hurt.

      (ii) However, it is not so  easy  to  make  this  defense,  since  now
      creating a corporation is easier and corporations  do  not  have  such
      limited powers.

      (iii) Even before this, courts tried to find a  way  about  the  ultra
      vires defense: estoppel, implied powers…

      (iv) Ultra  vires  defense  still  holds  in  some  cases:  non-profit
      activities (Dodge case).

(b) Social Responsibility: profit is the primary goal of the company.

      (i) The question is to what extent  should  corporations  look  beyond
      shareholders to other constituencies before making decisions?

           (I) it is rare for a company to be challenged for  making  these
           types of decisions, however some  conflict  may  arise  if,  for
           instance, large donations are made to director’s pet charities…

      (ii) Thus, whose interest should the directors look after when  making
decisions?

(c) Cases:

      (i) Shlensky v. Wrigley (Pinto 18, materials): the court held that the
      decision of the board not to install lights in a baseball stadium  was
      a matter of business policy which was untainted by  fraud,  illegality
      or self dealing; courts should  not  second  guess  directors  because
      their decisions are presumed to be in good faith.

           (1) Directors are given broad discretion in making decisions and
           may consider interests other than those of the shareholders.

           (2) Distinguished from the Ford case because the amount of money
           that was withheld in Ford was very large and problem of minority
           shareholders in a closely held corporation, needing a return  on
           their investments.

11. Promoters

(A) DEFINITION: PROMOTER IS THE  PERSON  THAT  HELPS  CREATING  A  BUSINESS,
BRINGING  THE  PARTIES  TOGETHER,  RAISING  CAPITAL,  MAKING   ARRANGEMENTS,
PROMOTING; PROMOTER ACTS ON BEHALF OF A  CORPORATION  TO  BE  FORMED  OR  IN
FORMATION.

(b) Liability: on preincorporation contracts, the promoter, instead  of  the
corporation, may be held liable for performance if  the  contract  does  not
expressly provide that the promoter will no longer be responsible  when  the
corporation comes into being.

12. Defective Incorporation

(A) DEFINITION: MAY OCCUR WHEN ARTICLES OF INCORPORATION  ARE  NOT  PROPERLY
FILED. SHAREHOLDERS ACT AS THOUGH THE CORPORATION HAS BEEN  FORMED  WHEN  IT
HAS NOT. ACTS PERFORMED, INCLUDING CONTRACTING, ARE  NOT  VOID,  BUT  MERELY
VOIDABLE IN CERTAIN CIRCUMSTANCES. THIS  ISSUE  IS  NO  LONGER  SO  RELEVANT
SINCE IT IS RIDICULOUSLY EASY TO INCORPORATE A BUSINESS. THERE IS  BASICALLY
NO EXCUSE FOR DEFECTIVE INCORPORATION.

(b) De Facto Corporation: a corporation that made a good faith start  toward
existence may contend that its existence  is  good  against  all  the  world
except the state. This  limits  the  shareholder  liability  that  otherwise
would be unlimited (if the corporation is not properly incorporated).

      (i)  Elements:  existence  is  permissible  by  law,  good  faith   in
      attempting incorporation, and  demonstration  of  actual  use  of  the
      corporate powers the participants believe themselves  to  have  (doing
      business under a corporate name).

      (ii) Caveat: it is contended whether the de facto corporation doctrine
      can be applied after the enactment of the MBCA and the RMBCA.

(c) Corporation by Estoppel: persons who have dealt with a  business  as  if
it  was  a  corporation  may  not  later  attempt   to   hold   shareholders
individually liable by alleging that the corporation  has  been  defectively
formed.

      (i) Caveat: it  is  contended  whether  the  corporation  by  estoppel
      doctrine can be applied after the enactment of the MBCA and the RMBCA.

13. Piercing The Corporate Veil

(A) DEFINITION: BYPASSING THE LIMITED LIABILITY IN A  CORPORATION  TO  REACH
THE SHAREHOLDERS’ INDIVIDUAL POCKETS (MAKE SHAREHOLDERS PERSONALLY  LIABLE).

This doctrine is not statutory, it has been created by the courts.

Although  limited  liability  is  beneficial  to  the  corporation  and  the
shareholders it has certain social costs.

There is an argument that limited liability makes sense for  contracts,  but
not torts, since in a contract case the  third  party  knows  who  they  are
dealing with, and in a tort this is impossible to plan.

Courts generally have not distinguished between  tort  and  contract  cases,
and there is no evidence that they are more likely to pierce  the  corporate
veil in tort situations.

 (b) Grounds for  Piercing:  intermixture  of  affairs,  lack  of  corporate
formalities, inadequate capitalization, evasion of a contract  (or  statute,
or with fraud purposes), and instrumentality theories.

      (i)  Intermixture  of  Affairs:  when  affairs  of  owners   and   the
      corporation  are  intermixed  and  third  parties  have  difficult  in
      separating the interests of the owners from the corporation.

      (ii) Lack of Corporate Formalities: courts are more likely  to  pierce
      the veil of corporations which do not attend to corporate  formalities
      (such as, inter alia, issuing stock  certificates,  holding  meetings,
      electing officers). RMBA requires that at least  one  more  ground  be
      present in order to pierce the veil.

      (iii) Inadequate Capitalization: if the capital is  illusory  compared
      with the business and the risks of loss.

           (1) Capital, for purposes of torts claims, is usually deemed  to
           be equity plus insurance coverage.

           (2) Courts decisions do  not  help  determine  what  constitutes
           adequate capital.

           (3) Courts are   divided on  whether  inadequate  capitalization
           alone is sufficient ground to pierce the veil.

           (4) Corporate owners are advised to  adequately  capitalize  the
           corporation to avoid the risk of personal liability.

           (5) Usually, courts do not require owners to update the  capital
           as the corporation grows. Analysis is confined in the  formative
           stages of the corporation.

      (iv) Evasion of a Contract: courts disregard the corporation  if  they
      find no reason to its existence other than evasion of a contract or  a
      statute, or incorporated with  the  sole  purpose  of  perpetrating  a
      fraud.

      (v) Instrumentality Theories: when a court finds  that  a  corporation
      exists solely to carry out the owner’s agenda, with no reason for  its
      own existence, the corporation  is  disregarded  and  the  owner  held
      liable. It requires other grounds.

(c) Equitable Subordination: in a bankruptcy or receivership,  claims  of  a
parent corporation may be asked by creditors to be subordinated to those  of
outside creditors (“Deep Rock Doctrine”; parent corporation is the  last  to
be paid).

      (i) Grounds are similar to those of piercing the veil.

      (ii) Too much debt in comparison  to  equity  increases  the  risk  of
      application of the doctrine.

      (iii) Shareholders lose all their  contribution  to  the  corporation,
      except personal assets.

(d) Cases:

      (i) Walkovsky  v.  Carlton:  the  court  held  that  although  grossly
      inadequate capitalization is a factor in determining whether to pierce
      the  veil,  it  is  not  dipositive.  Further,  having  several  small
      companies (in order to avoid liability) is not fraud and is not enough
      to pierce the corporate veil.

      (ii) Kinney: the  court  held  that  the  state  law  (West  Virginia)
      required the presence of two factor: grossly inadequate capitalization
      and disregard of  corporate  formalities.  The  sole  purpose  of  the
      corporation was found to be  to  perpetrate  a  fraud  and  the  court
      pierced the veil.

14. Theories Of The Firm

(A) REGULATORY APPROACH: MANAGERS  ARE  UNACCOUNTABLE  AND  LIKELY  TO  TAKE
ADVANTAGE OF THE SHAREHOLDERS;  THUS,  STRONGER  STATE  LAW  PROTECTION  AND
INCREASED FEDERAL PRESENCE ARE NECESSARY.

(b) Management Approach: managers protect the interest of  shareholders  due
to mutual interest in protecting the corporation;  thus,  laws  should  give
managers broad latitude in their activities.

(c) Law and Economics Approach: separation  of  ownership  from  control  is
beneficial because passive investors provide capital in return  for  profits
and managers are free  to  manage  and  maximize  profits;  thus,  abuse  by
managers would be controlled  privately  by  the  market  (poor  performance
indicates poor management), need to reduce costs (agency costs) and  private
contract (AoI, Bylaws).

15. Shareholders And Monitoring

(A) THE LEGAL MODEL: DIRECTORS AND MANAGERS HAVE  THE  AUTHORITY  TO  MANAGE
WHILE SHAREHOLDERS, AS OWNERS, HAVE SOME ABILITY TO  MONITOR  THE  MANAGERS’
PERFORMANCE.

(b) Shareholders: common shareholders  are  residual  claimants  (claims  on
assets,  upon  liquidation,  an  profits  follows  creditors  and  preferred
shareholders).

      (i) Election of Directors: Common shareholders select the directors.

      (ii) Relationship: relationship between shareholders and directors  is
      not legally an  agency/principal  relationship;  shareholders  do  not
      control the decisions of the directors. Directors must act  on  behalf
      of the corporation and all of the shareholders, not for the group that
      elected them. Directors are fiduciaries of the  corporation,  not  the
      shareholders.

      (iii) Right to Vote: shareholders can vote on election of  directors,
      filling of vacancies, and amendments to the bylaws and AoI. Also major
      structural issues  (such  as  mergers  and  liquidation  and  sale  of
      substantially all of the assets).  The  board  cannot  interfere  with
      voting rights.

           (1) Caveat: under  state  statutes,  amendments  to  the  bylaws
           usually do not require board approval, but the AoI do.

           (2) Usually, the voting required is a majority  of  the  quorum,
           although some  states  require  a  super  majority  for  certain
           actions. Quorum is established  in  the  Bylaws.  AoI  can  also
           require a super majority.

           (3) Cumulative Voting: permits  shareholders  to  collect  their
           votes and allocate them any way they choose. Must be  set  forth
           in the AoI.

                 (I) Formula to  determine  votes  necessary  to  elect  one
           director:

                       Sv

                 Sr >――― , where:

                       D+1

                 Sr is the number of shares  (in  the  quorum)  required  to
                 elect one director;

                 Sv is the number of shares voting; and

                 D is the number of directors to be elected.

                 (II) The lower the number of  directors,  the  greater  the
                 percentage necessary to elect a  director;  thus,  reducing
                 the size of the board is  a  tactic  to  defeat  cumulative
                 voting.

      (iv) Proxy Voting: proxies allow shareholders to vote certain  matters
      prior to a meeting or assign the voting right to  another  person  who
      will be present at the meeting.

      (v) Proxy Fight: when directors send out proxies to  the  shareholders
      requesting their votes  and  an  opposite  group  sends  out  its  own
      proxies, challenging the request of the directors.

      (vi)  Shareholder  Democracy:  significant  case  law  provides   that
      directors cannot act in a way  contrary  to  principles  of  corporate
      democracy to perpetuate their offices (Blausius v. Atlas Corp.).

      (vi) Vote Buying: vote under coercion, breach of  fiduciary  duty,  or
      vote buying is subject to limitations on that right  to  vote.  Voting
      arrangements among shareholders are usually upheld by the courts,  but
      courts look at the substance of the transaction and its object to find
      if it defrauds the shareholder.

      (vii) Right of Expression: significant case law provides  shareholders
      with additional rights not contained in  the  statutes,  such  as  the
      right to express themselves and  put  directors  on  notice  of  their
      desires before the next election (Auer v. Dressel).

           (1) Delaware’s courts tend to allow inspection  if  the  primary
           purpose is to solicit proxies.

           (2) Delaware statute distinguishes  between  inspection  of  the
           shareholder list and of the corporate books and records:

                 (I) Shareholder list: defendant corporation has the  burden
                 of proof to prove improper purpose.

                 (II) Corporate books and records: plaintiff shareholder has
                 the burden of proof on proper purposes.

      (viii) Right of Information: shareholders are  granted  the  right  to
      receive some information (federal securities laws and state law).

           (1) Financial statements;

           (2) Books and records or list of shareholders, so long as  there
           is a proper purpose (Pillsbury v. Honeywell).

(c) Cases:

      (i) Auer v. Dressel:  the  court  (NY  Court  of  Appeals)  held  that
      shareholders may express themselves and put on  notice  the  directors
      who will stand for election at the annual  meeting.  Shareholders  can
      propound and vote upon resolutions which, even if  adopted,  would  be
      purely advisory. Further the court stated that  if  shareholders  have
      the right to elect directors they have the implicit  right  to  remove
      them for good reason.

      (ii) Schnell: Just because what the board did is legal does  not  mean
      it is legal. The court will not allow interference with voting rights.

      (iii) Blausius v. Atlas Corp.: the court recognized the importance  of
      protecting shareholder  voting  and  found  that  the  board’s  action
      thwarted the shareholders. The action  of  the  board  was  found  not
      protected by the business judgment rule. A per se rule to  the  effect
      of prohibiting thwarting shareholder  voting  was  rejected,  but  the
      court applied a strict duty  of  loyalty  standard  which  shifts  the
      burden to the directors to demonstrate a compelling  justification  of
      their actions.

      (iv)  General  Datacomm:  plaintiff  wants  to   amend   bylaws   that
      outstanding stock options should not be repriced  without  shareholder
      vote. This is an issue of compensation, usually left to the board. The
      court does not address the issue, arguing that it is not ripe yet.

       (v) Pillsbury v. Honeywell: the court held that it  was  an  improper
      purpose the request of the shareholder list by a  shareholder  wishing
      to communicate with other shareholders about  his  opposition  to  the
      company’s manufacture of munitions used in the Vietnam War.  The  sole
      purpose of the shareholder was political, rather  than  economic.  The
      court applied Delaware  law,  but  Delaware’s  courts  tend  to  allow
      inspection if the primary purpose is to solicit proxies.

16. Board Of Directors

(A) BASIC PRINCIPLES: ELECTED BY THE SHAREHOLDERS. BOARD IS NOT LEGALLY  THE
AGENT OF THE SHAREHOLDERS. BOARD  CAN  ACT  WITHIN  ITS  POWER  TO  RUN  THE
CORPORATION,  EVEN  IF  THE  MAJORITY  OF   THE   SHAREHOLDERS   DISAPPROVE.
SHAREHOLDERS MAY ELECT DIFFERENT DIRECTORS AT THE  NEXT  ANNUAL  MEETING  OR
TRY TO REMOVE DIRECTORS CALLING A SPECIAL MEETING.

      (i) Directors act as fiduciaries to the corporation,  must  serve  the
      best interests of the corporation, including all shareholders and  not
      merely the interests of those who elect them.

(b) Board Structure: number of directors is usually set out  in  the  bylaws
or AoI. The board usually takes  actions  by  a  majority  vote.  Individual
directors who are not officers have no authority to act except  through  the
board.

(c) Independent Directors: nowadays, the law requires that  publicly  traded
companies have a majority of independent  directors.  Other  companies  (not
publicly  traded)  must  have  oversight   committees   comprised   of   all
independent directors.

(d) Meetings: rules on voting, notice and quorums are  usually  set  out  in
the bylaws.

17. Officers

(A) BASIC PRINCIPLES: APPOINTED BY THE BOARD, WHICH MAY REMOVE  OFFICERS  AT
WILL. DESIGNATION OF OFFICERS IS  MADE  BY  THE  BOARD  OR  BY  THE  BYLAWS.
OFFICERS RUN THE DAILY OPERATION OF BUSINESS.

      (i) Officers have a fiduciary duty to the corporation since  they  are
      corporate agents.

      (ii) Officers that serve  also  as  directors  are  known  as  “inside
directors”.

(b) Authority: officers’ power  originates  from  the  board.  Officers  are
agents of the corporation.

      (i) Three significant ways to an officer (agent) bind the  corporation
(principal):

      express, implied and apparent authority.

18. Federal Proxy Rules

(A) BASIC PRINCIPLES: A PROXY  IS  A  SPECIES  OF  AGENCY  RELATIONSHIP.  IT
ALLOWS SOMEONE (AGENT, THE PROXY HOLDER) TO VOTE ON BEHALF OF A  SHAREHOLDER
(PRINCIPAL, THE PROXY GIVER OR PROXY).

      (i) The agency is revocable.

      (ii) The Proxy holder  owes a fiduciary duty to the proxy.

      (iii) In publicly held corporations, proxy voting is highly  regulated
      (SEC, Securities Exchange Act of 1934, SEC Rule 14a).

(b) Proxy Solicitation: any request for  a  proxy,  or  to  execute  or  not
execute, or to  revoke,  a  proxy.  A  proxy  is  every  proxy,  consent  or
authorization relating to shares.

(c) Proxy Contest: also called proxy fight,  is  an  alternative  (sometimes
more effective) to other more expensive ways (such as  suing  or  purchasing
of shares to obtain control; but proxy fight is expensive also)  to  achieve
some objective in the corporation, which requires casting of votes.

      (i) Caveat: any press release, mass mailing,  or  other  communication
      that may be construed even as conditioning the shareholders group to a
      forthcoming  solicitation  is  itself  a  solicitation,   subject   to
      compliance with complex SEC’s proxy rules. But SEC Rule 14a-11  allows
      communication in certain  cases  (such  as  election  contests)  under
      certain conditions.

      (ii) When solicitation materials  are  completed  (including  pre–file
      with the SEC), the  corporation  shall,  within  five  business  days,
      furnish a copy of the shareholder list to the proxy holder or offer to
      may the proxy material (costs by  proxy  holder).  Pre–filing  may  be
      waived in specific cases (SEC Rule 14a–12).

(d) Antifraud Rule: prohibit any statement “which, at  the  time  and  under
the circumstances under which it  is  made,  is  false  or  misleading  with
respect  to  any  material  fact.”  (SEC  Rule  14a–9(a)).   General   rule,
applicable to “any proxy statement, form of proxy,  notice  of  meeting,  or
other communication, written or oral” in the proxy field.  Hard  to  comply,
material omissions or misleading statements are grounds  to  application  of
the antifraud rule.

      (i) SEC Rule 14a–9: in publicly held corporations, SEC Rule 14a–9, may
      be used, inter alia, to enjoin a proxy contender from using misleading
      statements, misrepresentations, nondisclosure or fraud  in  his  proxy
      solicitation, or, if the proxy has been already obtained,  from  using
      the proxy.

      (ii) State Law: if the corporation is not publicly traded (not a 12(g)
      corporation under the Securities Exchange Act), claims  must  be  made
      under state law.

      (iii) Standing to Sue: shareholder whose vote was sought by  means  of
      the offending proxy or the tender of whose shares was  sought  by  the
      bidder’s offer to purchase.

      (iv) Materiality: not every omission or half–truth is actionable, must
      be misleading to a hypothetical reasonable investor and propensity  to
      affect his thought process. Must be “material”.

      (v) State  of  Mind  (Fraud)  Required:  under  SEC  Rule  14a–9,  the
      negligence state of mind, or fault, is required. Not strict liability,
      proof of negligence required.

      (vi) Causation: under SEC  Rule  14a–9,  plaintiffs  need  only  prove
      materiality and not reliance. Also,  plaintiffs  may  prove  that  the
      solicitation of proxies was an “essential link” in the  accomplishment
      of the defendant’s  objective,  or  that  the  defendant’s  misleading
      statements or omissions foreclosed or caused then to forego state  law
      remedies they may otherwise have pursued (v. Mills).

      (vii) Remedies: usually, plaintiff seeks an  injunction  (against  the
      offending statements, against solicitation  of  further  proxies,  and
      against use of any proxy already obtained.

(e) Cases:

      (i) J.I. Case Co. v. Borak: the S. Ct. held that Section 14(a) of  the
      Securities Exchange Act, which grants power to  SEC  to  regulate  the
      solicitation of proxies,  provides  a  private  right  of  action  for
      Section 14(a) and Rule 14a–9 violations.

      (ii) Mills v. Electric Auto–Life Co.: the S. Ct. held that a plaintiff
      alleging  proxy  violations  must  demonstrate  materiality   of   the
      omission,  need  not  demonstrate  reliance,  and,  on  the  remaining
      causation  issue,  need   only   demonstrate   that   the   misleading
      solicitation was an “essential link” in accomplishing the result about
      which  plaintiff  complains.  Awards  of  attorney’s  fees  from   the
      corporate treasury if  the  plaintiff  shareholder  has  conferred  “a
      substantial benefit” on the corporation and fellow shareholders.

19. Shareholder Proposals

(A) SEC RULE 14A–8 PROPOSAL: A  SINGLE  PROPOSAL  AND  SUPPORTING  STATEMENT
(500 WORD LIMIT)  TO  BE  INCLUDED  IN  CORPORATE  MANAGEMENT’S  OWN  ANNUAL
SOLICITATION. NOT A PROXY CONTEST.

      (i)  Types  of  Proposals:  proposal   may   usually   be   a   social
      responsibility  proposal  (“stop   advertising   cigarettes”)   or   a
      governance proposal (executive compensation, request for secret voting
      by shareholders, redemption of poison pill).

      (ii) Eligibility and Procedure: proponent must have been a  record  or
      beneficial owner of shares for at least one year, at least $ 2,000  in
      shares or, if less, at lest 1% of the shares entitled to vote  on  the
      proposal (SEC Rule 14a–8(b)).

           (1) Proponent must continue ownership  until  the  date  of  the
           shareholders’ meeting. Failure to do so may cause  exclusion  of
           the proposal for any meetings  in  the  following  two  calendar
           years (SEC Rule 14a–8(h)(3)).

           (2) Proponent must represent that he will attend the meeting  to
           present the proposal. Failure to do so may  cause  exclusion  of
           the proposal for any meetings  in  the  following  two  calendar
           years (SEC Rule 14a–8(h)(3)).

           (3) Proponent must  provide  name,  address,  number  of  shares
           owned,  date  of  acquisition,   nomination   of   the   shares,
           documentation to support ownership, and proposal not  less  than
           120 days before the issuance of the  company’s  proxy  statement
           (SEC Rule 14a–8(e)(2)).

      (iii) State Limitations: under state statutes, shareholders have power
      only with a limited range of matters: amendments to the AoI,  mergers,
      sales of all or substantially  all  of  the  assets,  dissolution  and
      election and removal of directors. Initiative by shareholder  is  even
      more limited:  only  for  removal  of  directors  and  nomination  and
      election of directors. Other matters are subject to initiative by  the
      board.

           (1) Caveat: however, based on Auer  v.  Dressel  (v.  item  15),
           shareholders can propound and vote upon resolutions which,  even
           if adopted, would be purely advisory (right of expression).

                 (I) When shareholders propound a resolution as to a  matter
                 they  have  no  power  of  initiative,  language   of   the
                 resolution must be drafted as a request  or  recommendation
                 to the board. Otherwise, board may  exclude  proposal  (SEC
                 Rule 14a–8(i)(1)).

      (iv) Proxy Proposal Process: shareholder makes a timely submission  of
      his proposal, duly documented and informed; if the corporation decides
      to include the proposal in the proxy statement, end of the matter.  If
      less than 3% agree with the proposal, corporation may exclude  similar
      proposals for five years. In a second try,  if  less  than  6%  agree,
      exclusion may be for more five years. A third try  requires  10%  (SEC
      Rule 14a–8(i)(12) and 14a–8(i)(12)(i)).

           (1) To  omit  the  proposal,  the  corporation  must  request  a
           “no–action letter” from the SEC.

      (v) Ordinary Business Operations Exclusion: under SEC  Rule  14a–8,  a
      proposal may be excluded if it deals with a  matter  relating  to  the
      company’s ordinary business operations. To  avoid  exclusion  on  such
      ground, proposal must be drafted  in  the  form  of  a  recommendation
      without narrowly intervening with the day–to–day business activity.  A
      shareholder may  propound  resolutions  that  have  important  social,
      environmental or political implications but  the  proposal  also  must
      have a significant relationship to the business of the corporation.

      (vi) Other Exclusions: proposals related to the  election  to  office;
      proposals  that  would  cause,  if  implemented,  violation  of   law;
      proposals  aiming  mainly  personal  interest;  proposals  related  to
      specific  amounts  of  cash  or  stock  dividends;  others  (SEC  Rule
      14a–8(i)(1)–(13)).

(b) Cases:

      (i) Medical Committee for Human Rights v. SEC:  the  court  recognized
      that the corporation was trying to exclude the shareholder’s  proposal
      by  applying  a  distorted  criteria  in  considering   the   proposal
      interfered with the ordinary business operations. The court held  that
      the general economic and political exclusion required the proposal  to
      also involve a matter with no specific relation to  the  corporation’s
      business. The proposal was found to relate solely to a matter that was
      completely within  the  accepted  sphere  of  corporate  activity  and
      control. While decision on what a corporation manufactures are usually
      ordinary business decisions, napalm’s significance to the  corporation
      and its business was relevant and must  be  taken  into  account  when
      deciding the exclusion of the proposal. The court held that the action
      of the SEC was reviewable and that, in  view  of  repeated  management
      statements that its decision to continue manufacturing  and  marketing
      napalm  was  made  in  spite  of  business  considerations,  but  that
      management  considered  action  morally  and  politically   desirable,
      stockholder’s request  that  it  discontinue  making  napalm  must  be
      remanded to SEC so that it might reconsider it within proper limits of
      its discretionary authority and so that basis for its  decision  might
      appear clearly on the record.

20. Fiduciary Duties – Overview

(A) GENERAL: DIRECTORS AND OFFICERS  ARE  IN  A  FIDUCIARY  RELATIONSHIP  TO
THEIR CORPORATION AND TO  THE  SHAREHOLDERS.  CONTROLLING  SHAREHOLDERS  MAY
ALSO BE CHARACTERIZED AS FIDUCIARIES. FIDUCIARY DUTY SERVES AS  A  LIMIT  ON
THE POWERS OF THOSE IN POSITIONS OF CONTROL.

(b) Duty of Care: requires directors to perform their duties with  diligence
of a reasonable person in similar circumstances which may vary depending  on
the context. Involves poor decision making or  lack  of  attention,  but  no
personal benefit.

      (i) Directors can be liable  for  both  malfeasance  (wrongdoing)  and
      nonfeasance (failure to act).

      (ii)  Judicial  Review:  less  judicial  involvement.  Most  decisions
      involving duty of care are protected under the business judgment rule,
      which creates a presumption that limits courts in questioning business
      decisions. Courts will usually focus on the decision  making  process,
      not in the decision. Plaintiff usually has the  burden  of  proof  and
      courts rarely look at the substance of the decision.

           (1) Rationale for less judicial  involvement:  protect  business
           decisions that are intended to enhance corporate gain.

           (2) Defendants directors prefer duty of care analysis because of
           protection of the business judgment rule and burden of proof  on
           plaintiff.

(c) Duty of Loyalty: requires a fiduciary to act for the best  interests  of
the corporation and in good faith. Usually focuses on conflict  of  interest
(when personal interest of the fiduciary  prevails  over  the  corporation).
Prevents  directors  from  acting  against  the  best   interests   of   the
corporation or in such a way as to reap a personal  benefit  unavailable  to
other shareholders.

      (i)  Judicial  Review:  more  judicial  involvement.  Courts   usually
      scrutinize a conflict of interest transaction to determine  if  it  is
      fair. Burden of proof may be shifted to directors to show fairness and
      inquiry involves both the process and substance of the decision.

           (1) Rationale for more judicial involvement:  directors  may  be
           motivated by personal gain.

           (2)  Plaintiff  shareholders  prefer  loyalty  analysis  because
           defendants have the burden of proof  and  judicial  scrutiny  is
           active. Also, defendants  are  not  protected  by  the  business
           judgment rule.

(d) Other Standards of Judicial Review: courts  developed  different  levels
of scrutiny applicable to resolve situations in which  choice  for  analysis
under duty of care or under duty of loyalty is not clear.

      (i) Modified Business Judgment Rule: or proportionality  test.  Burden
      initially on defendant to justify its actions  and  some  scrutiny  is
      allowed of not only the process but also the substance of the decision
      (Unocal  Corp.  v.  Mesa  Petroleum).  Delaware  decision,   generally
      applied.

      (ii) Waste Standard: what the corporation received  in  a  transaction
      was so inadequate in value that no person of ordinary  sound  business
      judgment would  deem  it  worth  what  the  corporation  paid.  To  be
      wasteful, the transaction would have to be a  gift,  or  for  no  real
      consideration, or unnecessary. Limited  judicial  scrutiny.  Plaintiff
      has the burden of proof.

(e) Level of Judicial Scrutiny: level of judicial scrutiny  depends  on  the
standard of review, which is influenced by three main factors: the  type  of
the transaction (e.g.  ordinary  business  decision  or  self–dealing),  the
context of the transaction (e.g. publicly  traded  company;  control  group;
closely held company), and procedure  to  either  authorize  or  ratify  the
transaction (e.g. director are interested and voted,  shareholders  approval
required).

(f) Duty of Disclosure: directors  have  a  fiduciary  duty  to  communicate
honestly with the shareholders (Malone v. Brincat, Del. S. Ct.).

21. Duty Of Care

(A) STANDARD  OF  CARE:  WHAT  A  REASONABLE  PERSON  WOULD  DO  IN  SIMILAR
CIRCUMSTANCES (“ORDINARY PRUDENT PERSON”).

      (i)  Directors:  generally  should  have  some  understanding  of  the
      business, keep informed  on  activities,  perform  general  monitoring
      including attendance at meetings, and have some familiarity  with  the
      financial status  of  the  business  as  reflected  on  the  financial
      statements (Francis v. United Jersey Bank, NJ S. Ct.).

           (1) Duties of directors  of  publicly  traded  corporations  are
           greater than that of family–owned closely–held corporations.

           (2) Lack of involvement and failure to monitor managers indicate
           negligence.

(b) Duty to Monitor: directors should implement procedures and  programs  to
assist in their monitoring role.

(c) Business Judgment Rule: limits judicial inquiry into business  decisions
and protects  directors  who  are  not  negligent  in  the  decision  making
process. Burden of proof on the  plaintiff  and  judicial  scrutiny  of  the
process. Decisions  are  not  reviewed  even  if  they  are  wrong  or  poor
decisions.

      (i) In Delaware: presumption that in making a decision directors  were
      informed, acted in good faith and honestly believed that the  decision
      was in the best interests of the corporation.

      (ii) Directors must be able to make business decisions without fear of
      a lawsuit; directors are supposed to take risks, to produce gain.

      (iii) Caveat: rule protects mistakes, but not negligence in  making  a
      decision. Rule is inapplicable in the following cases:

           (1) malfeasance and (wrongdoing)  and  nonfeasance  (failure  to
           act), or prolonged failure to monitor or to act;

           (2) decision had no business purpose, was irrational or  created
           a no win situation;

           (3) action was ultra vires (beyond the  powers)  or  constituted
           waste.

           (4) directors had a conflict of interest or there was fraud, bad
           faith or illegality in the decision.

      (iv) Once the business judgment rule is rebutted, burden shifts to the
      defendant to prove entire fairness, and a duty of loyalty standard  is
      applied.

(d) Causation:  negligence  is  not  enough;  the  negligence  must  be  the
proximate cause of the loss.

      (i) Proof is difficult, specially  in  nonfeasance  cases  (as  it  is
      necessary to prove that if the director had done his duty there  would
      not be damage).

(e) Duty to Act Lawfully: public policy requires that the business  judgment
rule does  not  protect  an  illegal  activity  even  if  such  activity  is
beneficial to the corporation.

(f)  Caveat:  most  states,  like  Delaware  (§  102(b)(7)),   have   passed
legislation to protect directors  and  most  public  companies  have  placed
provisions in the AoI eliminating monetary damages for duty of care cases.

(g) Responsibility for Employees: the question is how far is  a  corporation
responsible for  the  behavior  of  employees.  Recent  cases  hint  that  a
directors should closely monitor. The  Sarbanes-Oxley  Act  states  that  in
publicly traded companies the management is required  to  attest  and  asses
their internal controls to shareholders  and  public,  and  accountants  are
required to give their view on the internal controls.

(h) Statutes:

      (i) ALI § 4.01: provides for duty of care of directors  and  officers,
      and the business judgment rule.

      (ii) Delaware § 102(b)(7): provision to protect directors, eliminating
      monetary damages for duty of care cases.

(i) Cases:

      (i) Francis v. United Jersey Bank: the NJ S.  Ct.,  in  a  nonfeasance
      case, found that a director was negligent for failure to  monitor  the
      managers or act to stop the managers from looting the company.

      (ii) Smith v. Van Gorkom: the Del. S. Ct. used  to  concept  of  gross
      negligence to conclude that the directors breached their duty of  care
      at a two–hour meeting in which the sale of the company  was  initially
      approved. The court found that the directors were uninformed and acted
      too hastily.  Decision  was,  thus,  not  protected  by  the  business
      judgment rule. The court also found that  a  shareholder  vote  cannot
      ratify a transaction approved with a lack of information.

22. Duty Of Loyalty

(A) GENERAL: REQUIRES A FIDUCIARY TO  ACT  IN  THE  BEST  INTERESTS  OF  THE
CORPORATION AND IN  GOOD  FAITH.  IN  GENERAL  IT  INVOLVES  A  CONFLICT  OF
INTEREST OR SELF DEALING. IT IS  NOT  AN  ISSUE  OF  MISMANAGEMENT,  BUT  OF
WILLFUL ACTIVITIES CONTRARY TO  THE  INTEREST  OF  THE  CORPORATION  OR  THE
SHAREHOLDERS.

(b)  Interested  Director  Transactions:  a  director  or  officer,   or   a
controlling  shareholder,  who  contracts  or   transacts   with   his   own
corporation, receiving a benefit that is not equally shared with  the  other
shareholders and thereby creating a conflict of interest (self–dealing).

      (i) Analysis: three issues should be kept  in  mind  in  analyzing  an
      interested director transaction:

           (1) What are the  legal  procedural  requirements  in  terms  of
           voting, quorum and disclosure?

           (2) How does compliance with those requirements affect the level
           of  judicial  scrutiny  applied  to  the  transaction  (business
           judgment rule, fairness, waste) or the burden of proof?

           (3) If there is a failure in the procedure, does that  void  the
           contract or have some other effect, such as increasing the level
           of judicial scrutiny or shifting the burden of proof?

      (ii) New York Statute: The transaction is not void solely because of a
      conflict of interest, or the voting  and  presence  of  an  interested
      director, if:

           (1) the transaction was approved by the disinterested  directors
           with disclosure of the conflicting interest; or  (2)  disclosure
           was followed by shareholder approval; or (3)  the  contract  was
           just and reasonable (fair) at the time of approval.

                 (I) Weak view: compliance with the statute was not intended
                 to change common law, which places the burden of  proof  on
                 the fiduciary and requires fairness. Conflict  of  interest
                 makes the transaction voidable, but close judicial scrutiny
                 is still required.

                 (II) Semi–strong view: compliance with either disinterested
                 board or  disinterested  shareholder  approval  shifts  the
                 burden of proof  to  the  plaintiff.  Fairness  remains  an
                 issue, no business judgment rule protection.

                 (III)  Strong  view:  compliance  with  the  statute   will
                 generally limit judicial scrutiny. Disinterested  board  or
                 shareholder approval not only shifts the burden of proof to
                 the plaintiff, but removes a fairness inquiry.

(c) Cases:

      (i) Lewis v. S.L. & E., Inc. (materials): the 2nd Cir. Ct. of  Appeals
      held that: (1) because the directors of plaintiff’s  corporation  were
      also  officers,  directors   and/or   shareholders   of   the   lessee
      corporation, the burden was on defendant directors to demonstrate that
      the  transactions  between  the  two  corporations   were   fair   and
      reasonable, (2) business judgment rule presupposes that the  corporate
      directors have no conflict of interest; (3) when a shareholder attacks
      a transaction in which the directors have an interest  other  than  as
      directors of the corporation, the directors may not escape  review  of
      the merits of the transaction; (4) when  a  corporate  transaction  is
      challenged in a derivative action against  the  interested  directors,
      they have the burden of proving that  the  transaction  was  fair  and
      reasonable to the corporation.

23. Executive Compensation

(A) GENERAL: COMPENSATION PAID TO EXECUTIVES AND DIRECTORS  MAY  RAISE  BOTH
DUTY OF CARE AND DUTY OF LOYALTY ISSUES. THERE IS LITTLE  JUDICIAL  SCRUTINY
OF SALARY AND BONUSES. DIFFERS FROM OTHER  INTERESTED  TRANSACTIONS  BECAUSE
THE COMPENSATION DECISION IS A NECESSARY ORDINARY  BUSINESS  DECISION  WHILE
OTHER CONFLICT OF INTEREST  TRANSACTIONS  ARE  OFTEN  SUBSTITUTES  FOR  ARMS
LENGTH BARGAIN TRANSACTIONS.

      (i) Stock Options: can result in very high compensation and allow  the
      recipient to buy the shares of the corporation for a period of time at
      a set price. The idea behind them was to align  the  interest  of  the
      management to those of the shareholders – increase the  value  of  the
      stock. This however had several problems:

           (I) The stock market goes insane and rises (like in the 1990s) –
           do you want to compensate managers for an insane market?

           (II) Managers have been found to skew the information available
           on the corporation to keep stock prices artificially high

           (III) Since there has to be available stock to exercise the
           option, managers have had corporations buy their own shares,
           which has driven share prices rise.

(b)  Judicial  Review:  executive  compensation  cases  in  publicly  traded
corporations are rarely successful. The use of outside directors in  setting
compensation will usually mean the business judgment  rule  will  apply  and
shareholder approval results in the waste test  (exchange  of  consideration
so disproportionately small that a reasonable  person  would  not  make  the
trade).  Burden  on  plaintiff.  Demand  may  be  required  before  bringing
derivative suit.

      (i) Post Enron, federal law requires shareholder vote for  almost  all
      stock option issues, making litigation even harder.

      (ii) Full disclosure is still necessary.

      (iii) Accounting practices are moving toward listing stock options  as
      expenses, so this is no longer a “free ride” for companies.

24. Corporate Opportunity

(A) GENERAL: IF AN INVESTMENT IS VIEWED AS BELONGING TO THE  CORPORATION  (A
CORPORATE OPPORTUNITY), THE CORPORATION SHOULD BE GIVEN THE  OPPORTUNITY  TO
INVEST IN IT.  LEGAL  TESTS  DETERMINE  WHICH  OPPORTUNITIES  ARE  CORPORATE
OPPORTUNITIES AND WHICH OPPORTUNITIES THE DIRECTORS AND  OFFICERS  MAY  TAKE
ADVANTAGE OF PERSONALLY. THIS MAY AMOUNT  TO  A  BREACH  OF  FIDUCIARY  DUTY
(DUTY OF LOYALTY). THE QUESTION RAISED IS A QUESTION OF INVESTMENT: CAN  THE
FIDUCIARY TAKE ADVANTAGE OF THE OPPORTUNITY, OR DOES THE OPPORTUNITY  BELONG
TO THE COMPANY?

(b) Legal Tests:

      (i) Interest Test: or expectancy test. Focuses  on  the  circumstances
      that indicate that the corporation had a special or unique interest in
      the opportunity. Fact–sensitive and difficult to apply  (for  instance
      it would apply if the corporation has a contract to buy something  and
      the fiduciary bids against the company).

      (ii) Line of Business Test: similar to the interest test, but broader.
      Test looks to how closely related the opportunity is to  the  existing
      business. A director or officer personally  taking  advantage  of  the
      opportunity would be competing  with  the  corporation.  Test  may  be
      viewed as too restrictive, as it may discard opportunities not closely
      related but  nonetheless  of  interest  to  the  corporation,  or  too
      expansive, as any opportunity may be  viewed  as  an  opportunity  for
      expansion. Some states include in this test an analysis of whether the
      company can afford the opportunity – Delaware courts hold that if  the
      company cannot financially purchase,  it  is  not  loss  of  corporate
      opportunity. Other courts have a broader view, where if the company is
      interested it will find a way to finance.

      (iii) Fairness Test: looks at the total circumstances to see if  there
      is unfairness and if the interests  of  the  corporation  call  for  a
      protection. Judicial scrutiny of the  process  and  substance  of  the
      transaction, with the burden of proof on the defendants). Some  courts
      combine the fairness test with the line of business test.

      (iv) The ALI Test: there is a corporate opportunity if the opportunity
      to engage in a business activity is presented to either the  directors
      or senior executives under circumstances  that  (1)  would  reasonably
      lead them to  believe  that  the  opportunity  was  intended  for  the
      corporation or (2) would require that they use  corporate  information
      and it  would  reasonably  be  expected  to  be  of  interest  to  the
      corporation. If the defendant is a  senior  executive,  the  corporate
      opportunity will also include any opportunity that he knows is closely
      related to the business in which the corporation is engaged or expects
      to be engaged.

           (1) Directors must offer the opportunity to the corporation with
           disclosure as to the conflict and the  opportunity.  Failure  to
           disclosure creates liability per se.

           (2) Corporation must reject  opportunity  before  fiduciary  may
           take advantage of it.

                 (I) Rejection by disinterested directors is subject to  the
                 business judgment rule.

                 (II) Rejection by shareholders  is  subject  to  the  waste
                 test.

                 (III) If rejection is neither  by  disinterested  directors
                 nor by disinterested shareholders, then the rejection  must
                 be fair to the corporation and the burden of  proof  is  on
                 the defendant to show that the rejection  is  fair  to  the
                 corporation.

(c) Cases:

      (i) Northeast Harbor Golf Club, Inc.  v.  Harris:  the  Maine  S.  Ct.
      rejected the line of  business  test  as  being  difficult  to  apply,
      rejected the fairness test because it is too open–ended  and  provides
      no real guidance to fiduciaries, and rejected the combination of  both
      tests because it would just combine the problems of both tests in one.
      The court held that the ALI Test should be applied by the trial  court
      and remanded.

25. Controlling Shareholders And Sale Of Control

(A) CONTROLLING SHAREHOLDERS: SHAREHOLDER OR GROUP  ACTING  TOGETHER  OWNING
51% OR MORE OF THE VOTING SHARES HAS CONTROL OF THE CORPORATION (CONTROL  OF
DECISIONS, INCLUDING ELECTION OF DIRECTORS). LESS THAN A MAJORITY  MAY  ALSO
HAVE CONTROL IF NO OTHER SHAREHOLDERS HAVE A SIGNIFICANT OWNERSHIP  INTEREST
(DE FACTO OR WORKING CONTROL), SPECIALLY IN  PUBLICLY  TRADED  CORPORATIONS.
MAY  CREATE  CONFLICT  OF  INTEREST  BETWEEN   CONTROL   GROUP   AND   OTHER
SHAREHOLDERS.

(b) Fiduciary Duty: the main issue  regarding  controlling  shareholders  is
that they basically have control of the board of directors who then  respond
to these shareholders (although they shouldn’t). This may  raise  issues  of
fiduciary duty to the minority  shareholders,  in  cases  where  the  courts
found that the directors were acting as agents of  the  shareholders.  These
make cases of duty of loyalty.

      (i) Caveat: context matters. Some  Delaware  cases  suggest  that  the
      courts will not scrutinize parent-subsidiary situations closely.

(c) Sale of Control: usually buyers pay a premium  for  controlling  shares,
since this gives you control over the business. Raises the issue of  whether
a  equal  treatment  (equal  opportunity)  should  be  given  to  the  other
shareholders (buyer be obligated to buy the  shares  pro  rata  or  purchase
100% of the business and offer everyone the same price).

      (i) General View: absent looting of corporate  assets,  conversion  of
      corporate opportunity, fraud or bad faith, a  controlling  shareholder
      is free to sell, and a purchaser is free to  buy,  the  control  at  a
      premium price.

      (ii) Looting: if the only reason for the  purchase  of  control  at  a
      premium is to loot  the  business  (sell  the  assets  and  “dry”  the
      corporation), directors or controlling shareholder may be held liable.

      (iii) Securities Law: requires that if someone makes a  public  tender
      offer to buy a certain amount of shares of a company, they have to buy
      pro rata at the same price.

(d) Cases:

      (i) Perlman v. Feldmann: explored the idea  of  equal  opportunity  to
      share the premium paid to the controlling shareholders. The court held
      that the shareholders had an equal opportunity in  the  premium  which
      was  allocated  pro  rata  to  all  the  shareholders,  including  the
      controlling shareholder. The rule is narrow: equal opportunity will be
      the rule if the seller is in  effect  selling  a  corporate  asset  or
      opportunity, or acting in a detrimental way toward the corporation  or
      other shareholders.

26. Derivative Suits

(A) GENERAL: CORPORATION LITIGATION CAN BE DIRECT OR DERIVATIVE.

(b) Direct Action: one or more shareholders  sue  the  corporation  alleging
that the corporation has denied them a right  associated  with  shareholding
(e.g. rights to dividends or disclosure); action  is  in  the  name  of  the
shareholder; damages recovered are paid to the shareholders.

(c) Derivative Action: shareholders sue to  vindicate  the  violation  of  a
duty owed to the corporation, either  fiduciary  duties  owed  by  corporate
directors or officers, or  obligations  of  a  third  party  pursuant  to  a
contract  with  the  corporation.  Shareholders  act  on   behalf   of   the
corporation. Recovery goes to the corporate treasury.  Attorneys’  fees  are
due to the plaintiff winner and are  paid  by  the  corporation.  Derivative
suits were created by courts of equity, not legislation.

      (i) Requirements to Plaintiffs:

           (1) own shares contemporaneously with the wrongdoing;

           (2) post security for the defendant’s costs;

           (3) make a demand on the directors to take action;

           (4) be “record” owners of shares;

           (5) verify the truth of pleadings, rather than plead based  upon
           “information and belief”;

           (6) adequately represent shareholders interests;

           (7) maintain shareholding during the litigation.

      (ii) Caveat 1: if the allegation is that mismanagement or self dealing
      has resulted in a decline in the value of one’s shares, the action  is
      always derivative.

      (iii) Caveat 2: in structuring the claim, finding a direct harm to the
      shareholder (e.g. denial of rights associated with  shareholding)  may
      be a good strategy to qualify the action as direct and avoid posting a
      bond. If there are both direct and derivative claims,  the  choice  is
      the plaintiff’s.

      (iv) Caveat 3: closely held corporation, according to the ALI Project,
      is an exception to the derivative action norm. Courts sometimes permit
      recovery to go to plaintiffs (pro rata), instead of to the  corporate,
      in closely held corporation.

(d) Demand Rule: means whereby  the  board  has  an  opportunity  to  manage
litigation in the corporation’s name  or  on  its  behalf.  Opportunity  for
intra–corporate dispute resolution,  as  by  receiving  and  acting  upon  a
demand, the board may save the corporation great expense.  Demand  may  also
filter or stop abusive strike suits. Demand is usually made by a  letter  to
the board sent by the shareholder.

      (i)  Demand  Refused:  the  board  rejects  the   demand   after   due
      deliberation, preceded by investigation of the facts.

           (1) Grounds for Refusing: law has not been violated; not in  the
           corporation’s best interests.

                 (I) If shareholder files a lawsuit, board alleges  that  it
                 has considered and refused the  demand,  business  judgment
                 rule. Bad scenario for plaintiff.

      (ii) Demand  Accepted:  board  notifies  shareholder  that  the  board
      intends to take action on the demand. Once  accepted,  shareholder  no
      longer has rights in the litigation.

           (1) Settlements: settlement may  be  entered  with  the  alleged
           wrongdoer (e.g. a director) or with the shareholder–plaintiff in
           the derivative action itself.

      (iii) Demand Excused:  demand  is  excused  (shareholder  may  file  a
      lawsuit without prior demand to the board)  when  the  corporation  is
      threatened  with  irreparable  harm;  when  it  is  a   closely   held
      corporation; when the corporation is taking too long to respond;  when
      demand was made and the corporation takes no position  on  the  issue;
      when demand is deemed “futile”.

           (1) Futility: demand is futile if the board will not give a fair
           hearing on the issue. A  critical  mass  of  the  directors  are
           motivated by an illicit objective (revenge, spite, jealousy), or
           have a material interest on  the  claim,  or  are  dominated  or
           controlled by a director or shareholder who does have a conflict
           of interest.

                 (I) Where officers and directors  are  under  an  influence
                 which  sterilizes  their   discretion,   they   cannot   be
                 considered proper persons to conduct litigation  on  behalf
                 of the corporation. In applying this principle,  the  court
                 asks if there is a reasonable doubt that the directors  are
                 disinterested  and  independent  or  that  the   challenged
                 transaction was the product of a valid exercise of business
                 judgment.

                 (II) Delaware: only routes to demand excused are  financial
                 interests of a critical mass of directors;  domination  and
                 control of a majority  of  the  directors  by  one  of  the
                 parties  to  the  underlying  transaction;  or  proof  that
                 directors  who  had  acted  at  the  earlier  time  of  the
                 underlying transaction could not have had the protection of
                 the business judgment rule.

                 (III) New York: more flexible than Delaware.

(e) Special Litigation Committees: some corporations have SLC that are  made
up of independent directors  who  analyze  whether  the  litigation  can  go
through or not. The courts will then look at the decision  of  the  SLC  and
place the burden of proof on the Committee to show that litigation  was  not
appropriate. Further, the courts will also  look  at  the  interest  of  the
directors, since although allegedly independent this is rarely the case.

(f) Cases:

      (i) Marx v. Akers: the NY Ct. of Appeals held that demand was  excused
      because a majority of the directors were interested in  the  decision.
      The trial court, on remand, found that demand was excused because “(1)
      a majority of the directors are interested in the transaction, or  (2)
      the directors failed to  inform  themselves  to  a  degree  reasonably
      necessary about the  transaction,  or  (3)  the  directors  failed  to
      exercise their business judgment in approving  the  transaction.”  But
      also found that “a board is not interested ‘in voting compensation for
      one of its members as an executive or  in  some  other  nondirectorial
      capacity, such as a consultant to the corporation’”. The court further
      states (see the last footnote of  the  case)  that  when  there  is  a
      majority of interested directors the adequate test is not waste, it is
      fairness. However, in  this  case  the  waste  test  applied  and  the
      plaintiff failed to show waste.

27. Mergers And Acquisitions

(A) GENERAL: MERGER IS A METHOD OF ACQUISITION OF  ANOTHER  CORPORATION,  IN
WHICH PURCHASER AND PURCHASED COMPANIES ARE COMBINED. INVOLVES  EXCHANGE  OF
CONSIDERATION  IN  THE  FORM  OF  SECURITIES,  CASH  OR  A  COMBINATION   OF
CONSIDERATION. THE MERGER PLAN MUST BE  APPROVED  BY  THE  BOARD.  THE  IDEA
BEHIND A MERGER IS THAT THE TWO CORPORATIONS COMBINED  WILL  BE  WORTH  MORE
THAN INDIVIDUALLY (IF THERE IS NO GAIN THERE WOULD BE NO REASON TO  MERGE  –
HOWEVER, THIS IS NOT ALWAYS THE CASE).

(b) Direct Merger: one corporation is  directly  incorporated  into  another
(Corporation B is directly incorporated into Corporation A, and  Corporation
B disappears as a legal entity). This  requires  initial  approval  by  both
boards of directors, followed by a vote of both shareholder bodies.

(c) Consolidation: corporations A and B are merged  into  a  new  company  C
(both corporations A and B disappear as legal entities).

(d) Triangular Merger: acquiring company A forms a wholly  owned  subsidiary
C and acquired company B  mergers  into  C.  Usually  used  when  company  A
whishes  to  keep  the  assets  acquired  from  company  B  in  a   separate
corporation. Or to avoid contingent liabilities. Shareholders of  company  B
may receive shares  of  company  C.  Company  A  votes  in  company  C,  but
shareholders of company A vote only in company A.

(e) Reverse Triangular Merger: acquiring company  A  forms  a  wholly  owned
subsidiary C. Company C is  then  merged  into  acquired  company  B,  which
becomes a wholly owned subsidiary of company A. Usually used when company  A
whishes to preserve the existence of the acquired company.

(f) Sales of Assets: acquiring company A acquires substantially all  of  the
assets  of  company  B.  Both  boards  must  approve  the  transaction,  and
shareholders of B have a right  to  vote  when  the  sale  involves  all  or
substantially all the assets of B.

(g) Tender Offer: or takeover bid. Company A makes an offer directly to  the
shareholders of company B to buy their stock. Objective  is  to  acquire  at
least 51% of the shares. Requires the  board  approval  of  company  A,  but
requires no board approval from company B. Shareholders  of  company  B  can
either accept or reject the offer. The  Williams  Act  of  1934  (Securities
Act) protects the shareholders of B under  the  rules  of  full  disclosure.
Tender is hostile if the board of  company  B  disapproves  or  resists  the
offer.

(h) Appraisal Remedy: shareholders who object to the merger may dissent  and
seek appraisal as a remedy. Shareholder is then entitled to be paid  by  the
corporation in cash an amount equal to the fair market value of his  shares.
Problems and limitations: procedure  requirements  (shareholders  must  vote
against merger and serve notice of their wish to seek appraisal), costs  (at
the dissenting shareholders expense),  uncertainty,  freezeouts.  There  are
several approaches to appraisal:

      (i) Delaware Block Approach: valuation methodology in which the  value
      of the shares is determined by looking  at  market  value,  net  asset
      value and earnings value.

      (ii) New Methodology: expanded the Delaware  Block  Approach  applying
      valuation techniques generally acceptable in the  financial  community
      (e.g. comparative takeover premiums, discounted cash flow).

(i) Defacto Merger: an acquisition structured as a sale of assets  with  the
acquiring corporation also assuming the liabilities will not have  appraisal
rights available in the event valuation is challenged  by  the  shareholders
of the selling corporation. In this case, shareholders may  argue  that  the
transaction is a defacto merger and seek  appraisal.  Claim  would  probably
not prevail  in  Delaware  if  the  transaction  technically  complies  with
statutory provision.

(j) Cases:

      (i) Piemonte v. New Boston Garden Corp.: in evaluating a company,  the
      court assigned the components of  the  appraisal  as  follows:  market
      value (10%), earnings value (40%) and net asset value (50%). Court did
      not fully explain why it used the particular weights  it  did.  Highly
      criticized: limited, too conservative,  does not  reflect  the  actual
      value  of  the  company,  and  the  values  it  came  up   with   were
      unsubstantiated by the facts and not supported by explanations.

28. Freezeouts Under State Law

(A) FREEZEOUTS: CONTROLLING SHAREHOLDERS FORCING THE  MINORITY  SHAREHOLDERS
TO RELINQUISH THEIR EQUITY POSITION IN THE CORPORATION. USUALLY, COMPANY  A,
WHICH CONTROLS PUBLIC COMPANY B, SETS UP A SHELL  CORPORATION  C  (A  WHOLLY
OWNED SUBSIDIARY OF COMPANY A); COMPANY A USES ITS CONTROL OF THE  BOARD  OF
COMPANY B TO ENTER INTO A MERGER WHEREBY COMPANY B MERGERS INTO  COMPANY  C;
THE MERGER PLAN PROVIDES THAT THE MINORITY SHAREHOLDERS OF  COMPANY  B  WILL
RECEIVE  CASH  OR  DEBT  SECURITIES  FOR  THEIR  SHARES,  RESULTING  IN  THE
ELIMINATION OF THEIR OWNERSHIP IN COMPANY B.

      (i)  Two–tier  Offer:  a  tender  offer  followed   by   a   freezeout
      transaction. Usually when bidder wants  100%  ownership  but  acquires
      less in the tender offer due to the inevitable  holdouts.  Control  is
      acquired in the tender offer and freezeout is intended to acquire  the
      remaining shares. If the price offered to the minority  is  less  than
      paid to acquire control, this may be unfair.

      (ii) Front–loaded Two–tier Offer: in  a  hostile  takeover,  a  higher
      price is offered in the tender offer to the public to gain 51% control
      but the public was informed that once control was acquired there would
      be a second step freezeout merger at a lower price. Tactic  viewed  as
      coercive.

(b) State Law: to perform a freezeout, the control group  must  comply  with
the state regulation for mergers and fiduciary obligations.  For  a  merger,
approval by the board and  shareholder  vote  are  required  (some  statutes
require no shareholder vote when the control group owns a large  percentage,
usually 90%, of the corporation).

      (i) Generally, to avoid appraisal, minority shareholders  use  federal
      securities laws or state fiduciary duty doctrine to  enjoin  freezeout
      or seek damages.

      (ii) Generally, courts will scrutinize freezeouts by control groups as
      a duty of loyalty issue requiring entire fairness  (fair  dealing  and
      fair price) and, in some cases, requiring a business purpose  for  the
      transaction.

           (1)  Fair  Dealing  involves  full  disclosure  and   procedural
           fairness issues such  as  timing,  initiation,  negotiation  and
           structure;

           (2) Fair Price relates to all the factors which affect the value
      of the shares

(c) Shareholder Ratification: in some cases, shareholder vote may be  sought
to ratify a transaction entered by  the  board  that  may  raise  issues  of
conflict of interests. Or to try to reduce the level of  judicial  scrutiny.
To have an effect, shareholder ratification must  involve  the  approval  of
disinterested  shareholders  (if  there  is   a   controlling   shareholder,
ratification  requires  approval  of  a  majority  of  the  minority).  Full
disclosure is required, or the vote is inoperative.

(d) Cases:

      (i) Weinberger v. U.O.P. Inc.: in analyzing a  freezeout  transaction,
      the Delaware S. Ct. eliminated the requirement of a  business  purpose
      and limited the use of  equitable  relief  in  freezeouts.  The  court
      focused on the concept of fairness (fair dealing and fair price).  The
      court found a lack of fair dealing. Approval  of  a  majority  of  the
      minority shareholders had no effect on  entire  fairness  because  the
      shareholders  were  not  given  full  disclosure  of  the   bargaining
      positions of the parent and subsidiary. The  Delaware  Block  Approach
      valuation methodology was expanded  to  include  techniques  generally
      acceptable by the financial community. Complex and extensive decision.
      Courts will not “undo” the merger, but the shareholders  are  entitled
      to recissory damages. The fairness test  applies:  if  there  is  fair
      dealing, but unfair price: appraisal;  if  there  is  unfair  dealing:
      recissory damages.

      (ii) In Re Wheelabrator Technologies Litigation: the Delaware Chancery
      Court found that the ratification of a merger by the majority  of  the
      minority shareholders fully informed extinguished  the  duty  of  care
      claim, because the failure of the board to  act  in  an  informed  and
      non–negligent manner was a voidable act cured by the shareholder vote.
      The duty of loyalty claim was viewed under the business judgment rule,
      as the court found that the acquiring company was  not  a  controlling
      shareholder and used the following rationale:

           (1) in a duty of loyalty claim relating to  interested  director
           transactions where there was  no  controlling  shareholder,  the
           issue was subject to the business judgment  rule  and  plaintiff
           had the burden to show that the transaction was wasteful;

           (2) in a duty of loyalty claim relating to transactions  with  a
           controlling shareholder, more  judicial  scrutiny  was  required
           (the standard of proof is entire fairness), but the ratification
           had the effect of shifting the burden of proof to the  plaintiff
           to prove  unfairness  (there  is  concern  because  there  is  a
           controlling shareholder who may influence the decisions).

29. Hostile Takeovers

(A) GENERAL: A HOSTILE TAKEOVER TAKES PLACE WHEN COMPANY  A  (BIDDER)  WANTS
TO ACQUIRE COMPANY B (TARGET) AND THE BOARD OF COMPANY B IS NOT IN FAVOR  OF
THE ACQUISITION. TWO MEANS ARE AVAILABLE:

      (i) proxy fight: to try to convince shareholders of company B to  vote
for a new board favorable to the acquisition;

      (ii) tender offer: offer is  made  directly  to  the  shareholders  of
company B, to acquire their stock. This will usually require two steps

           (I) the tender offer

           (II) freezeout merger (Weinberger rules apply).

                 a. in Delaware if you own 90% of a company  you  can  do  a
                 shortform merger, that does not require  the  usual  merger
                 issue (shareholder vote, disclosure…), and  the  only  step
                 left is appraisal.

(b) Bidder Tactics:  generally,  bidder  acquires  a  target  by  purchasing
control through a tender offer.

      (i) Tender is made for enough shares to gain control.

      (ii) All shareholders are entitled to an equal opportunity  to  tender
their shares.

      (iii) Bidder may set conditions to accept  tendered  shares,  such  as
      receipt of a certain  number  of  shares  (to  avoid  owning  a  large
      percentage of shares without the benefits of control). If more  shares
      are tendered than the bidder wants, shares are purchased on a pro rata
      basis. Cash is often used.

      (iv) If bidder wants complete control of the target, bidder will  need
      to acquire shares not tendered in the offer in a second–step freezeout
      transaction, such as in a front– loaded two–tier offer.

(c) Federal law rules: the Williams Act established a certain set  of  rules
regarding takeovers:

      (i) Anyone acquiring 5% or more  of  a  company  had  to  file  a  13d
      statement (signaling device to the  market  that  a  hostile  takeover
      could take place.

      (ii) Requirement of full disclosure to target shareholders.

      (iii) There is no requirement to acquire 100% of the company, however,
      all shareholders in the tender offer get the same price and sell their
      shares on a pro rata basis.

      (iv) Rule 14e gives the SEC and the Courts to  prevent  any  fraud  or
      manipulation in tender offers.

(d) Target Tactics:  tactics  are  aimed  to  delay  a  bidder  from  taking
immediate control or preclude bidder from using certain offensive tactics.

      (i) Shareholder Vote Required: some tactics require amendments to  the
      AoI and, thus, a shareholder vote.

           (1) Staggering the terms of the directors  (some  directors  are
           elected each year, so immediate control of the board  by  bidder
           is delayed);

           (2) Super–majority or disinterested shareholder vote requirement
           in selling assets (bidder will have problems in  paying  finance
           and implementing freezeout);

           (3) Provision establishing fair price for shares  or  compulsory
           redemption of shares not tendered even if the  bidder  does  not
           want those shares;

           (4) Recapitalization and creation of a new class of shares  with
           supervoting  rights  (if  supervoting  class  is  owned  by  the
           managers, hostile tender offer fails).

      (ii) Shareholder Vote Not Required: some tactics  can  be  implemented
      without a shareholder vote.

           (1) “Crown  Jewel  Defense”:  selling  off  or  option  to  sell
           significant  assets  to  a  third  party  (corporation  is  less
           appealing to a bidder);

           (2) Split the corporation to increase overall value;

           (3)  Self–tender:  target  purchases   shares   from   its   own
      shareholders;

           (4) “White Knight”: target  seeks  another  bidder  to  come  to
      target’s rescue;

           (5) Management Buyout: managers  takeover  the  target,  usually
           with the use of debt (leveraged buyout);

           (6) Increase debt to  limit  bidder’s  ability  to  finance  the
      tender offer.

           (7) Poison Pill: at some triggering event (usually the  purchase
           of a certain percentage of  the  target’s  shares),  the  target
           shareholders are given rights  to  obtain  securities  (debt  or
           equity). Securities can be from the bidder (flip over  plan)  or
           from the target (flip in plan). These rights  make  the  hostile
           tender  offer  more  expensive  for  the  bidder  by   adversely
           affecting either the target or the bidder itself. Prior  to  the
           triggering event, the target directors can  redeem  the  rights,
           but after the event the rights become non–redeemable.

(e) State Law: actions to defend a corporation from a takeover  usually  are
faced with a charge of breach of fiduciary duty to the corporation  and  its
shareholders  under  state  law.  Judicial  scrutiny  usually  applies   the
modified business judgment rule.

      (i) The Unocal Test:  generally  applies.  In  Unocal  Corp.  v.  Mesa
      Petroleum,  the  Delaware  S.  Ct.  recognized  that  when   directors
      implement a defensive tactics the board may be acting primarily in its
      own interest, and ruled that if a defensive measure  is  taken  within
      the business judgment rule, it must be reasonable to the threat posed.
      Concerns of the board may include inadequacy  of  the  price  offered,
      nature and timing of  the  offer,  illegality,  impact  on  creditors,
      employees and  the  community,  risk  of  nonconsumption,  quality  of
      securities being offered in the exchange. Threat is often based on the
      belief that the bidder has offered insufficient value.

           (1) Thus, in enacting a defensive tactic the  board  must  prove
           (I) that it had reasonable grounds for believing that  a  danger
           to corporate policy and effectiveness  existed;  (II)  that  the
           defensive tactic was reasonable to the threat posed.

           (2)  The  presence  of  a  majority  of  independent   directors
           unaffiliated with the target enhances the directors’ proof.

           (3) Initial burden on directors and some scrutiny  of  not  just
           the process but also the substance of the decision.

           (4) First step focuses on the directors  acting  in  good  faith
           after reasonable investigation; the second step allows the court
           to balance the defensive tactic with the threat.

           (5) Gives directors significant  latitude  while  allowing  some
           closer judicial scrutiny of the tactics.

      (ii) The Revlon Test:  applies  if  the  breakup  of  the  company  is
      inevitable or the control is on sale. In Revlon, Inc.  v.  MacAndrews,
      the decision of the Delaware S. Ct. indicates  that  concerns  by  the
      directors with other constituencies during a takeover (such  as  those
      permitted within the Unocal test) are permissible only  if  there  are
      rationally related benefits accruing to shareholders. But, once  there
      is an auction for the business (more than one bidder), such  interests
      are inappropriate. Duties of the board change from preservation of the
      target to maximization of value to  the  shareholders.  Directors  are
      auctioneers.

(f) Summary: when shareholders challenge the  actions  of  directors,  there
are generally three levels  of  review:  business  judgment  rule,  Unocal’s
enhanced scrutiny and the duty of loyalty.

(g) Cases:

      (i) Moran v. Household International, Inc.: target could issue a right
      for every common share if a bidder announced a tender for 30%  of  the
      stock of the target or if someone acquired 20% of  the  stock  of  the
      target. Flip over plan (target shareholders who did  not  tender  have
      the option the bidder’s shares at a substantial discount). Bidder  was
      only obligated after a freezeout merger. The Delaware  S.  Ct.  upheld
      the poison pill plan.  The  court  found  that  the  Delaware  statute
      permitted issuance of rights and preferred  shares;  that  the  poison
      pill did not preclude an offer since a bidder  could  still  buy  less
      than 100% of the corporation and the pill would not apply,  or  try  a
      proxy fight. The poison pill was there as  a  “just-in-case”  measure,
      there was no hostile takeover at the time. The court analyzed that the
      poison pill foreseen here seemed adequate, but  that  in  case  of  an
      actual takeover it would have to be looked at again in detail.

      (ii) Revlon, Inc. v. MacAndrews:  the  Delaware  S.  Ct.  applied  the
      enhanced scrutiny of Unocal and held that when a target is up for sale
      the directors cannot play favorites (use defensive tactics  to  choose
      the bidder). Duties of the  board  change  from  preservation  of  the
      target to maximization of value to  the  shareholders.  Directors  are
      auctioneers, shall seek the highest price for shareholders.

      (iii) Paramount Communications, Inc. v. Time,  Inc.:  (Time  –  Warner
      case). The court held  (together  with  Time)  that  the  Unocal  test
      applied, since the breakup of the  company  was  not  inevitable.  The
      court placed a strong emphasis on the ability  of  directors  to  make
      long term plans for the shareholders or the company. Emphasis was also
      placed on the fact that there was no controlling shareholder.

      (iv) Paramount Communications, Inc. v. QVC  Networks,  Inc.:  in  this
      case, Paramount argued that Time applied, since  the  breakup  of  the
      company was not inevitable.  The  court  held  that  the  Revlon  test
      applied,  since  Viacom  (Paramount’s  “choice”)  had  a   controlling
      shareholder that would ultimately have control of Paramount. The court
      stated that the Revlon test applies where the breakup of  the  company
      is inevitable or where the ultimate sale of the company involves  sale
      of control.  In all other cases, Unocal applies.

30. Rule 10B–5

(A) SCOPE: SEC RULE 10B–5, AUTHORIZED BY SECTION  10(B)  OF  THE  SECURITIES
EXCHANGE ACT OF 1934, IS THE  GENERAL  ANTIFRAUD  RULE  APPLICABLE  TO  “THE
PURCHASE OF  ANY  SECURITY.”  PROHIBITS  MATERIAL  OMISSIONS  OR  MISLEADING
STATEMENTS, WHETHER ORAL OR WRITTEN. RULE IS NOT LIMITED  TO  SECURITIES  OF
PUBLICLY HELD CORPORATIONS, MISREPRESENTATION IN A  SMALL  OR  CLOSELY  HELD
CORPORATION MAY BE ACTIONABLE.

      (i) Disclosure: requires full disclosure of information.

      (ii) Insider Trading: use  of  nonpublic  information  by  any  person
      “having a relationship [director, officer,  attorney]  giving  access,
      directly or indirectly, to information intended to be  available  only
      for a corporate purpose and not for the personal benefit of anyone. By
      use of the information to trade or to tip others who trade,  a  person
      makes a gain or avoids a loss by remaining silent when there is a duty
      to speak.

(b) Private Rights of Action: Rule 10b–5 gives a private  right  of  action;
not limited to enforcement by SEC, investors can  sue  for  damages  or  for
injunctive relief based on the rule.

(c) Standing to Sue: only those who have  actually  purchased  or  sold  the
security at issue (purchaser–seller rule).

(d) Materiality: the omitted or misstated fact, if known, must be such  that
it would have assumed  actual  significance  in  the  deliberations  of  the
reasonable shareholder. One of which the reasonable  investor  would  attach
importance in the making of his decision. One which would have a  propensity
to affect the reasonable investor’s thought process. A fact  is  a  material
fact if there exists substantial likelihood that  a  reasonable  shareholder
would consider it important in  deciding  whether  to  purchase  or  sell  a
security. On materiality, see Basic, Inc v. Levinson.

(e)  State  of  Mind:  measure  of  the  degree   of   fault   (scienter   -
intentionality). Courts typically recognize five  levels  of  fault:  strict
liability, negligence, recklessness (highly unreasonable  omission,  extreme
departure from the standard of ordinary care, danger  so  obvious  that  the
actor must  have  been  aware  of  it),  knowing  conduct,  and  intentional
conduct. But for Section 10(b)  purposes,  the  US  S.  Ct.  held  that  its
language is limited to  prevention  of  knowing,  intentional,  or  possibly
reckless conduct, but negligent conduct is not included.

(f) Reliance (Transaction Causation): given proof of  materiality,  reliance
is presumed. If a reasonable investor would have considered it important  if
the fact had been disclosed, the courts  presume  the  particular  plaintiff
would have considered it important.

      (i)  In  cases  where  the  plaintiff  is  alleging  reliance   on   a
      misrepresentation, it is not necessary for the plaintiff  actually  to
      have seen the press  release,  quarterly  report,  or  other  document
      containing the alleged misstatement. Proof  of  indirect  reliance  is
      sufficient. If the plaintiff can link his conduct (buying  shares)  to
      the defendant’s fraud by showing that “the fraud was  a  ‘substantial’
      or  ‘significant  contributing  cause’,  the   plaintiff   has   shown
      sufficient reliance to support his 10b–5 claim.”

      (ii) Plaintiff’s reliance must be reasonable. Reasonableness is judged
      by considering

           (1) sophistication of the plaintiff;

           (2) existence of personal relationships;

           (3) access to relevant information;

           (4) existence of fiduciary relationship;

           (5) concealment of the fraud;

           (6) opportunity to detect the fraud;

           (7) whether plaintiff initiated the stock transaction or  sought
           to expedite the transaction;

           (8) generality or specificity of the misrepresentation.

(g) Reliance (Fraud  on  the  Market  Theory):  may  be  utilized  in  cases
involving publicly traded securities. Based on the ECMT. If the  corporation
has issued disclosures that  are  false  or  misleading,  or  which  contain
material omissions, then market  prices  will  not  accurately  reflect  the
state  of  affairs  within  the  corporation.  Investor’s  reliance  on  the
integrity of the market will have been misplaced. Successful  invocation  of
the fraud on the  market  theory  establishes  a  presumption,  and  only  a
presumption, of reliance (see Basic, Inc v.  Levinson).  Valuable  tool  for
plaintiffs.

(h) Loss Causation: in a Rule 10b–5 case, the plaintiff must  establish  not
only a causal link  between  the  defendant’s  alleged  wrongdoing  and  the
plaintiff’s conduct (transaction causation), but also a causal link  between
the defendant’s acts and the plaintiff’s loss or damages (loss causation).

      (i)  Plaintiff  must  prove  that  “but  for”  the  defendant’s   acts
      (misstatement, omission), the decrease  in  market  price  (and  loss)
      would not have occurred. Or prove that the misstatements or  omissions
      were a “substantial factor” in producing the  loss  the  plaintiff  as
      suffered. Proximate causation.

(i) The “In Connection With”  Requirement:  means  of  testing  whether  the
connection between securities, or even  securities  markets  generally,  and
the fraud alleged, is too attenuated.

(j) Privity:  Rule  10b–5  has  no  privity  (direct  dealings  between  the
plaintiff and the defendant) requirement.

(k) Secondary Liability for Disclosure Violations: plaintiffs  often  pursue
secondary  violators   (defendants   corporate   directors   and   officers,
accountants,  consultants,  attorneys,  bankers,  celebrities)  because  the
primary  violator,  often  the  issuer  of  the   securities,   has   become
judgment–proof (insolvent). After a decision of the S. Ct. in  Central  Bank
of Denver v. First Interstate Bank of Denver, establishing the liability  of
secondary  violators  participants  in  securities  transactions  is   quite
difficult under Rule 10b–5.

(l) Freezeouts: in a freezeout, a Rule 10b–5 cause of action may  arise  for
the minority shareholders if there is a lack of full disclosure that  forces
the minority shareholders to exchange in the merger (that  is,  sell)  their
shares. However, use of Rule 10b may be limited by the S.  Ct.  decision  in
Santa Fe v. Green.

(m) Cases:

      (i) Basic, Inc v. Levinson: sellers of stock during  period  prior  to
      formal announcement of merger brought Rule 10b–5 action  in  which  it
      was alleged that material misrepresentations  had  been  made  due  to
      denial of merger negotiations prior to official announcement.  The  S.
      Ct. noted that “it  is  not  enough  that  a  statement  is  false  or
      incomplete, if the misrepresented fact  is  otherwise  insignificant.”
      The court held that:

           (1) standard of materiality appropriate  in  §  10(b)  and  Rule
           10b–5 context is: an omitted fact is  material  if  there  is  a
           substantial likelihood  that  its  disclosure  would  have  been
           considered significant by a reasonable investor;

           (2) materiality in merger context depends  on  probability  that
           transaction will be consummated, and its significance to  issuer
           of securities (thus, materiality depends on the facts and is  to
           be determined on a case–by–case basis); and

           (3)   presumption   of   reliance,   supported   in   part    by
           fraud–on–market  theory  may  be  applied,  but  presumption  is
           rebuttable (Rule 10b–5 defendants may attempt to show  that  the
           price was not affected by their misrepresentation, or  that  the
           plaintiff did not trade in reliance  on  the  integrity  of  the
           market price).

      (ii) Santa Fe v. Green: minority shareholder brought an action against
      majority shareholders and a firm which  had  appraised  value  of  the
      stock for purposes of permitting the company in question to undergo  a
      Delaware short–form merger. The S. Ct. held that where, on  the  basis
      of information provided, the minority shareholders could either accept
      the price offered for their shares or reject it and seek appraisal  in
      the Delaware court of chancery, their case was  fairly  presented  and
      the transaction as alleged in  the  complaint  was  therefore  neither
      deceptive nor manipulative and therefore did not  violate  either  the
      Securities Exchange Act provision or SEC rule 10b–5. The  court  found
      that there was no fraud since there was no lack of disclosure  by  the
      control group. Mere instances  of  corporate  mismanagement  in  which
      essence of the complaint is that shareholders were treated unfairly by
      a fiduciary are not within the statute or rule. The Court limited  the
      use of Rule 10b-5 to cases involving deceit, holding  that  causes  of
      action based on breach of fiduciary duty belong in state court.

      (iii) Diamond v. Oreamuno:  stockholder’s  derivative  action  against
      corporate officers. The NY Ct. of Appeals found that  insider  trading
      does harm the corporation and violates duties the insider owes to  it:
      “Although the corporation may have little concern with the  day–to–day
      transactions in its shares, it has a great interest in  maintaining  a
      reputation of integrity, an image of probity, for its  management  and
      in insuring the continued public acceptance and marketability  of  its
      stock. When officers and directors abuse their position  in  order  to
      gain personal profits, the effect may  be  to  cast  a  cloud  on  the
      corporation’s name, injure stockholder relations and undermine  public
      regard for the corporation’s securities.”  The  court  held  that,  if
      corporate officers solely by virtue  of  their  position  as  officers
      learned of drop  in  corporate  earnings  and  sold  their  shares  of
      corporate stock before publishing information  as  to  loss,  officers
      would be liable  to  corporation  for  profits  resulting  from  sale.
      Diamond permits a derivative suit for insider trading which allows for
      a corporate recovery. It doesn’t matter  if  the  corporation  suffers
      harm. There is a breach of a fiduciary duty.

31. Insider Trading

(A) NATURE OF THE INSIDER TRADING  PROHIBITION:  THE  PROHIBITION  UPON  THE
INSIDER IS “DISCLOSE  OR  ABSTAIN”.  BECAUSE  THE  PREROGATIVE  TO  DISCLOSE
USUALLY  IS  THE  CORPORATION’S,  AND  NOT  THE  INSIDER’S,  THE   EFFECTIVE
PROHIBITION BECOMES TO “ABSTAIN” FROM TRADING, OR  FROM  TIPPING  OTHERS  TO
TRADE. NOTE: TO BE LIABLE OF INSIDER TRADING YOU HAVE TO TRADE IN  YOUR  OWN
STOCK.

(b) Who is an Insider?: a  person  who,  because  of  a  fiduciary  duty  or
similar relation, is afforded access  to  nonpublic  investment  information
from his corporation. Requires a fiduciary or similar relationship with  the
other parties to the transaction, that is, the  shareholder  of  the  target
corporation  who  sold  the  shares  (see  Chiarella  v.   United   States).
Attorneys, accountants, investment bankers,  consultants,  may  also  become
insiders, or temporary insiders, when they learn  of  nonpublic  information
during the course of performing services for the corporation. Access to  the
information  has  to  arise  from  a  fiduciary  relationship,  or   similar
relation, to those persons who sell shares while the insider is buying.

      (i) SEC Rule 14e–3: prohibits any “person  who  is  in  possession  of
      material information relating to [a] tender offer” to  trade  on  that
      information without any reference to duty.

(c) Tipper–Tippee Liability: an insider who passes  information  to  another
person knowing that the other person will trade  is  a  tipper.  Whether  he
trades or not, tipper has the same liability  as  an  insider  who  actually
trades. Recipient of the information is  a  tippee,  and  also  has  insider
trading liability, but only if he trades. Liability of tippee is  derivative
of tipper; a benefit test applies.

      (i) Benefit Test: determine whether the insider’s  tip  constituted  a
      breach of the insider’s fiduciary duty, which depends upon whether the
      insider (tipper) will personally benefit, directly or indirectly, from
      his disclosure. Absent some personal gain (tangible or intangible), no
      breach of duty.  Because  the  tippee’s  duty  is  derivative  of  the
      tipper’s, the tippee cannot be held liable if the tipper  breached  no
      duty (see Dirks v. SEC).

(d) The Misappropriation Theory: developed by courts, “holds that  a  person
commits fraud ‘in connection with’ a  securities  transaction,  and  thereby
violates § 10(b) and  Rule  10b–5,  when  she  misappropriates  confidential
information for securities trading purposes, in breach of  a  duty  owed  to
the source of the information”, rather than in a breach of  a  duty  to  the
investor on the opposite side of the trade, as in the  “classical”  case  of
insider trading.  Someone  who  steals  (or  converts)  the  information  in
violation  of  a  duty  owed  to   the   owner   of   the   information   (a
misappropriation), or their tippee (“fraud on the source”). A thief  may  be
held liable under the misappropriation theory.(i)  The  S.  Ct.  upheld  the
misappropriation theory (see United States v. O’Hagan).

(e) Remedies and Enforcement: persons  who  trade  “contemporaneously”  with
trading by a misappropriator may sue for damages.

(f) Insider Trading Prohibition under State Law: the majority of the  states
apply the expanded special facts doctrine, which claims that an insider  has
the duty to disclose any material facts which  insider  knows  a  reasonable
investor or shareholder would want to know in making the decision to buy  or
sell.

(g) Cases:

      (i) Chiarella v. United States: petitioner,  who  was  employed  by  a
      financial printer that had been engaged  by  certain  corporations  to
      print corporate  takeover  bids,  deduced  the  names  of  the  target
      companies from information contained in  documents  delivered  to  the
      printer  by  the  acquiring  companies  and,  without  disclosing  his
      knowledge, purchased stock in the target companies and sold the shares
      immediately after the takeover attempts were made public. The  S.  Ct.
      held that:

           (1) employee could not be convicted  on  theory  of  failure  to
           disclose his knowledge to stockholders or target companies as he
           was under no duty to speak, in that he  had  no  prior  dealings
           with the stockholders and was not their agent or  fiduciary  and
           was not a person in whom sellers  had  placed  their  trust  and
           confidence, but dealt with them only through  impersonal  market
           transactions;

           (2) section 10(b) duty to disclose  does  not  arise  from  mere
           possession of nonpublic market information; and

           (3) court would not decide whether employee breached a  duty  to
           acquiring corporation since such theory was not submitted to the
           jury.

      Liability is premised upon a duty to  disclose  (such  as  that  of  a
      corporate insider to shareholders of his corporation) arising  from  a
      relationship of trust and confidence between parties to a transaction.
      Petitioner had no affirmative duty to disclose the information  as  to
      the plans of the acquiring companies. He was not a corporate  insider,
      and he received no confidential information from the target companies.
      Nor could any duty  arise  from  petitioner's  relationship  with  the
      sellers of the target companies’  securities,  for  he  had  no  prior
      dealings with them, was not their agent, was not a fiduciary, and  was
      not  a  person  in  whom  the  sellers  had  placed  their  trust  and
      confidence. A duty to disclose under § 10(b) does not arise  from  the
      mere possession of nonpublic market information.

      (ii) Dirks v. SEC: a former employee exposed a company’s ongoing fraud
      to a securities analyst, who then informed  his  own  clients  of  the
      fraud without successfully alerting the public. The S. Ct.  held  that
      unlike insiders who have independent  fiduciary  duties  to  both  the
      corporation and its shareholders,  the  typical  tippee  has  no  such
      relationships. There must be a breach of the insider’s fiduciary  duty
      before the tippee inherits the duty to disclose or abstain. A duty  to
      disclose arises from the relationship between parties and  not  merely
      from one’s ability to acquire information because of his  position  in
      the market. Tippees must assume an insider’s duty to the  shareholders
      not because they receive inside information, but rather because it has
      been made available to them  improperly.  Thus,  a  tippee  assumes  a
      fiduciary duty to the shareholders of a corporation not  to  trade  on
      material nonpublic information only when the insider has breached  his
      fiduciary duty to the shareholders by disclosing  the  information  to
      the tippee and the tippee knows or should know that there has  been  a
      breach. In determining whether a tippee  is  under  an  obligation  to
      disclose  or  abstain,  it  is  necessary  to  determine  whether  the
      insider's “tip” constituted a breach of the insider’s fiduciary  duty.
      Whether disclosure is a breach of duty depends in large  part  on  the
      personal benefit the insider receives as a result of  the  disclosure.
      Absent  an  improper  purpose,  there  is  no  breach   of   duty   to
      stockholders. And  absent  a  breach  by  the  insider,  there  is  no
      derivative breach.

      (iii) United States v. O’Hagan: after a company retained a law firm to
      represent it regarding a potential tender offer for another  company’s
      common stock, respondent O’Hagan, a member of the law firm who did  no
      work on the representation, began  purchasing  call  options  for  the
      target company, as well as shares of the stock.  Following  the  law’s
      firm  withdrawal  from  the  representation,  the  tender  offer   was
      announced and the price of the target  stock  rose  dramatically,  and
      O’Hagan sold his call options and stock at a profit of more than $ 4.3
      million. The S. Ct. held that:

           (1) criminal liability under § 10(b) of Securities Exchange  Act
           may be predicated on misappropriation theory;

           (2) defendant who purchased stock in target corporation prior to
           its being purchased in tender offer, based on inside information
           he acquired as member of law firm representing  tender  offeror,
           could be found guilty of securities fraud in violation  of  Rule
           10b–5 under misappropriation theory; and

           (3) Securities and Exchange Commission (SEC) did not exceed  its
           rulemaking   authority   in   promulgating   rule    proscribing
           transactions in  securities  on  basis  of  material,  nonpublic
           information in context of tender offers.

      A corporate “outsider”  violates  §  10(b)  and  Rule  10b-5  when  he
      misappropriates  confidential  information  for   securities   trading
      purposes, in breach of a fiduciary duty owed  to  the  source  of  the
      information,  rather  than  to  the  persons  with  whom  he   trades.
      Misappropriation, as just defined, is the proper subject of a §  10(b)
      charge because it  meets  the  statutory  requirement  that  there  be
      “deceptive” conduct “in connection  with”  a  securities  transaction.
      First, misappropriators deal in deception: A  fiduciary  who  pretends
      loyalty to the principal while  secretly  converting  the  principal's
      information for personal gain  dupes  or  defrauds  the  principal.  A
      company’s confidential information qualifies as property to which  the
      company has a right of exclusive use; the undisclosed misappropriation
      of such information constitutes fraud akin to embezzlement. §  10(b)’s
      requirement that the misappropriator’s deceptive use of information be
      “in connection with the purchase or sale of [a] security” is satisfied
      by the  misappropriation  theory  because  the  fiduciary’s  fraud  is
      consummated not when he  obtains  the  confidential  information,  but
      when, without disclosure to his principal, he uses the information  in
      purchasing or selling securities.

32. Closely–Held Corporations

(A) GENERAL: THE MAIN ISSUE  REGARDING  CLOSELY  HELD  CORPORATIONS  IS  THE
MINORITY SHAREHOLDER AND THE PROTECTION OF THE MINORITY  SHAREHOLDER.  THERE
ARE TWO TYPES OF PROTECTION:
      (i) Ex Ante protection: if you know you are going to  be  an  investor
in a company, how can one legally contract to overcome the  problem  of  the
minority shareholder.
      (ii) Ex Post protection: if there is no ex ante  contract  (or  a  bad
contract), how does the law protect the minority shareholders.
(b) Devices to Maintain Control: (ex ante protection) by voting together  on
a consistent basis or by getting the majority to agree, a group of  minority
shareholders may be able to elect some directors and then maintain  whatever
control they possess. Classical devices are  shareholder  voting  agreement,
irrevocable proxies, voting trusts, class voting, and cumulative voting.
      (i) Shareholder Voting Agreement: all signing shareholders shall  vote
      as they shall agree or, failing agreement, as a designated  individual
      (e.g. a lawyer) directs. Alternatively, the agreement may provide that
      all signatories agree to vote as a majority of the group,  or  “pool”,
      decides.
           (1) Many states provide  that  a  shareholder  voting  agreement
           shall be specifically enforceable.
           (2) To optimize enforcement, shareholder voting agreement  shall
           be detailed as to the consequences should one party breach it.
      (ii) Irrevocable Proxies: allows its holder to vote the shares without
      needing judicial enforcement (self–executing).
           (1) If not expressly revoked, a proxy is considered revoked by a
           later proxy given to another, by the shareholder’s attendance at
           the meeting, or, in any case, by the passage of  eleven  month’s
           time.
           (2) Caveat: irrevocability of a proxy will be  upheld  when  the
           agency is given to protect the interests  of  the  principal  in
           addition to protect some independent interest of the agent, over
           and above the  normal  agent’s  interests  such  as  employment,
           compensation and the like (e.g. irrevocable  proxy  given  to  a
           bank to vote for shares as guaranty). Agency  “coupled  with  an
           interest”  (or  “powers  given   as   securities”).   Otherwise,
           irrevocable proxies are not upheld by the courts.
      (iii) Voting Trusts: shareholders may discuss matters, but the trustee
      has no obligation to listen to them. Complete severance of voting  and
      ownership. All voting rights are in the trustee’s hands.
           (1) An illegal voting trust is simply one that fails  to  comply
           with statutory requirements that the voting trust be  of  record
           at the corporation’s  principal  offices  (not  secret)  and  be
           limited in duration, often ten years.
           (2) The trustee owes fiduciary duties of care and loyalty to the
           participating shareholders.
           (3) Proper purpose doctrine applies: a voting trust will not  be
           upheld if it  is  found  to  have  fraud,  illegality  or  other
           improper objective.
      (iv) Class Voting: e.g. AoI  providing  for  two  classes  of  shares,
      identical in all respects except for voting rights. “A” shares  to  be
      held by one group, “B” shares by the other, each group of shares  with
      the right to elect a number of directors.
      (v) Cumulative Voting: gives a shareholder the  right  to  cast  votes
      equal to the number of shares he holds times the  number  of  director
      positions standing for election. Shareholder may cumulate his votes on
      one or two positions rather than vote evenly over all positions up for
      election.
      (vi) Supermajority Voting requirements: the contract can  provide  for
      supermajority voting in certain circumstances, which is a way to  give
      minority shareholders a sort of veto power over majority decisions.
           (I) The concern is that the minority will use the  supermajority
           requirement to control the majority.
           (II) In certain instances, supermajority requirements  can  lead
           to deadlock in voting, and that is bad for business (this  is  a
           business concern, not a legal one).
(c)  Protecting  Shareholder  Expectations  Ex  Ante:  shareholder  may   be
protected  by  contract  (e.g.  shareholder  agreement),  by  long–term  job
security (tenure) and salary agreement. Agreements may limit  the  authority
of the board. But courts may limit such limitations.
(d) Restrictions on Share Transferability: three basic  restrictions:  first
refusal, which prohibit a  sale  of  shares  unless  the  shares  are  first
offered to the corporation, the other shareholders, or both,  on  the  terms
the third party has offered; first options, which prohibit a sale of  shares
unless the selling shareholder first offers the shares to  the  corporation,
the other shareholders, or both, at a price fixed under the  agreement;  and
consent  restrains,  which  prohibit  a  transfer  of  shares  without   the
permission of the corporation’s board of  directors  or  other  shareholder.
Agreements are knows as buy– sell agreements.
      (i) Umbrella Test:  in  analyzing  whether  restraint  is  reasonable,
      courts search for a determination of whether  the  agreement  has  the
      intent  and  result  of  keeping  shareholders  in  (a  restraint   on
      alienation), or is merely the  result  of  allowing  shareholders  the
      opportunity to control  who  their  “partners”  will  be  (permissible
      private ordering).
(e)  Protecting  Shareholder  Expectations  Ex  Post:  without   contractual
protection, participants may face the problem of illiquidity  (e.g.  no  one
to sell shares) and exploitation (e.g. majority receives high  salaries  and
benefits). In courts, exploited shareholders allege that participants  in  a
close corporation owe fiduciary duties, not only to the corporation, but  to
one another (a heightened duty), or allege that  have  been  “oppressed”  by
those in control.
      (i) Summary of  Choices:  a  minority  shareholder  oppressed  by  the
      control group may have the following choices:
           (1) sue for breach of fiduciary duty, requiring  the  defendants
           to pay back to the corporation benefits they have received;
           (2) invoke the “equal opportunity”  rule  alleging  that  he  is
           entitled to benefits parallel to those the  controlling  faction
           is receiving;
           (3)  sue  alleging  oppression  (e.g.   denial   of   reasonable
           expectations,   such   as    dividends,    salary,    meaningful
           participation in governance), seeking involuntary dissolution of
           the corporation if the statute  authorizes  it;  in  this  suit,
           plaintiff may seek for alternative relief (e.g. appointment of a
           provisional director).
(f)  New  York  Statutory  Provisions:  New  York  Statute  §1104-a  permits
dissolution of the corporation under special  circumstances  (the  plaintiff
shareholder – or group of shareholders –  must  own  at  least  20%  of  the
corporations shares). The dissolution is permitted when “oppressive  action”
is found. The business is auctioned off or  sold.  The  corporation  or  the
majority shareholders can opt to purchase the shares and the corporation  is
not dissolved. Courts have  found  other  remedies  (equitably)  under  this
statute,
(g) Cases:
      (i) McQuade v. Stoneham: the NY Ct. of Appeals held that “stockholders
      may, of course, combine  to  elect  directors.”  But  “a  contract  is
      illegal and void so far as it precludes the board of  directors…  from
      changing officers, salaries or policies or  retaining  individuals  in
      office, except by consent of the contracting parties.” Contract  could
      be enforced to elect the plaintiff director,  but  not  to  elect  him
      officer. The aim was the protection of minority shareholders not  part
      of the shareholder agreement.
      (ii) Clark v. Dodge: the  NY  Ct.  of  Appeals  held  that  “[i]f  the
      enforcement of a particular contract damages nobody – not even, in any
      perceptible degree, the public – one sees no  reason  for  holding  it
      illegal”. The court held that a contract requiring the plaintiff to be
      elected officer could be enforced and, according to the  contract,  he
      could remain in office only so long as he continued to  be  “faithful,
      efficient and competent.” The court distinguished from McQuade in that
      in this case all the shareholders had  entered  into  the  shareholder
      agreement.
      (iii) Wilkens v. Springside Nursing Home: the S. Judicial  Ct.  of  MA
      held that majority shareholders in  close  corporation  owed  duty  of
      utmost  good  faith  and  loyalty  in  their  dealings  with  minority
      shareholder;  that  majority  shareholders  did  not  show  legitimate
      business purpose for removing minority shareholder from the payroll of
      the corporation, which had never paid dividends, or  for  refusing  to
      reelect him as a salaried officer and director; and that damages  owed
      to the minority shareholder could not  be  diminished  by  claim  that
      duties which had previously been performed by the minority shareholder
      for his salary had since been performed by other persons. The standard
      the court applies is the “reasonable expectations  when  entering  the
      business” standard. It is a two step balancing test.
           (i) First the board  has  to  show  legitimate  purpose  in  its
           actions.
           (ii) The burden of proof shifts to the plaintiff, who  then  has
           to show that there were other, less burdensome means of carrying
           out that same purpose.
      (iv) Kemp v. Beatley: the NY  Ct.  of  Appeals  held  that:  (1)  when
      majority shareholders of close corporation award de facto dividends to
      all shareholders except class of minority  shareholders,  such  policy
      may constitute “oppressive actions”  and  serve  as  basis  for  order
      dissolving  the  corporation;  (2)  the  provision   for   involuntary
      dissolution was properly applied;  and  (3)  change  in  policy  which
      amounted to nothing less than an attempt to exclude  petitioners  from
      regaining   any   return   on   their    investment    through    mere
      recharacterization of distributions of corporate  income,  constituted
      oppressive action within meaning of corporate dissolution statute.

                                   The End